Defined benefit pension plan - Financial definition
Concise definition of the term defined benefit pension plan
A defined benefit pension plan is a retirement plan in which an employer promises a specified monthly benefit upon retirement, based on the employee's earnings history, tenure of service, and age. The employer bears the investment risk and is responsible for ensuring that there are sufficient funds to pay the promised benefits.
Comprehensive definition of the term defined benefit pension plan
A defined benefit pension plan guarantees a fixed, pre-established benefit for employees upon retirement, making it a crucial part of employee benefits in many traditional industries, especially in the public sector. The calculation of benefits typically considers factors such as the employee's average salary over the last few years of employment and the total number of years worked. These plans require significant actuarial and investment management expertise to ensure the promised benefits are adequately funded.
Employers often make regular contributions to a pension fund, and the plan may be subject to regulatory oversight to protect beneficiaries' interests. An example of a defined benefit plan is a government pension where employees receive a percentage of their final salary based on years of service. Unlike defined contribution plans, where employees assume investment risk, defined benefit plans place the funding and investment risks on the employer, which can lead to significant liabilities on the company's balance sheet if the plan is underfunded.