A strong retirement strategy can give you the opportunity to plan for the future—including spending more time with family, volunteering in your community and enjoying the things you love.
For workers who have the option, an employer-sponsored defined benefit plan is one way you can prepare for retirement. These plans are designed to provide you with a preset annual income after you've stopped working. They can help you feel more certain that you'll have financial support to last throughout your retirement years.
What is a defined benefit plan?
With a defined benefit plan, commonly known as a pension, employers provide participating employees with a set income for life upon retirement. "Defined benefit" refers to the fact that you and your employer know your retirement income in advance—what you'll get is spelled out, sometimes exactly.
Pensions work, in essence, like this:
- Your employer makes the contributions that fund the account directly, and they manage it.
- Your benefit amount is usually calculated based on your income and years of service.
- When you retire, you'll receive regular payments for life, or you may be able to take a lump-sum payout.
How does a defined benefit plan work?
Your employer controls the defined benefit plan
If your workplace offers a pension, your employer is responsible for making the contributions, managing the investments and ensuring there's enough money to pay out the promised benefit. They may opt to set requirements, such as you having to work for a certain amount of time before the money becomes fully yours (known as "vesting"). But as long as you qualify, the pension payments are guaranteed—you'll know exactly how much you'll be eligible to receive when you retire and can plan around it.
Your employer calculates your plan benefits
Your employer will use a set formula to calculate the defined benefit you'll receive when you retire. It usually factors in:
- Your final average salary
- Your time with the company
- A benefit multiplier
The benefit multiplier is a percentage set by your employer and determines what portion of your salary you'll get for an annual pension. For example, if your final average salary was $60,000 after 20 years, and your employer's multiplier is set at 2%, your annual pension would be $60,000 x 20 years x 2%, or $24,000 per year. You'll want to pay attention to the guidelines of your particular plan to learn how to maximize your potential benefit.
This calculated amount has limits that are set by the IRS. The maximum annual benefit for a pensioner is:
- For 2023: The lesser of either 100% of the employee's average salary for their top three consecutive earning years or $265,000.
- For 2024: The lesser of either 100% of the employee's average salary for their top three consecutive earning years or $275,000.
You have little responsibility but also little investment control
When your employer controls your retirement plan and guarantees you a set retirement income, it can simplify part of your long-term planning and reduce some of the potential risks. That's because with a defined benefit plan, you don't fund the account or have to monitor it for optimal investment returns.
The drawback is that you also don't have a say in how the money is invested. And, in most cases, you can't change the contributions to your plan.
Those are options you do have with
When you have a defined contribution plan, you won't know exactly how much you'll have for potential retirement income. It depends on how much you put in and what the market does. But with a defined benefit plan, you don't have to worry about that because you're guaranteed to receive a preset amount.
Defined benefit plan payment options
Once you retire, you'll get the amount your employer has promised as part of the defined benefit plan. Depending on your plan type, you may have options for how you'll get that money.
Defined benefit plans most commonly pay out installments,
One fair concern with a monthly payment is that you may not live long enough to earn back all you're owed. In this case, some plans offer a joint and survivor payout option, where your spouse or beneficiary could receive a monthly benefit after your death.
Depending on the details of your pension plan, you may be able to take a one-time payout rather than installments. Or you may have a particular kind of pension with a lump-sum aspect, such as a cash balance plan. With these, your employer makes the contributions and manages the investments, but your end-result benefit isn't payments for life but instead is the total account value. You'll then have to manage the money yourself, and face the potential risk of outliving your money or losing some of it to a volatile stock market.
There are pros and cons to each payout type, and even more nuance to consider depending on your particular plan. Talking through your payout options with a financial advisor ahead of retirement can help you weigh any risks and rewards.
Navigate retirement with confidence
Defined benefit plans certainly have some valuable aspects, from shifting some retirement investing responsibilities to your employer to knowing you'll have a predictable income that will last from retirement through the rest of your life.
But you may have questions about how to best put those retirement dollars to work. And you may want help seeing how a pension fits in with other retirement savings options and your long-term goals. It can help to get the perspective of a