Defined Benefit Plans or Traditional Pension Plans

Reading material

1. https://www.irs.gov/retirement-plans/defined-benefit-plan

What Is a Defined-Benefit Plan? Examples and How Payments Work

https://www.investopedia.com/terms/d/definedbenefitpensionplan.asp

By Julia Kagan

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

Updated May 25, 2025

A defined-benefit plan is a retirement savings plan where the employer guarantees a monthly benefit for the employee, based on factors like salary and years of service.

Defined-Benefit Plan: An Overview

A defined-benefit plan is an employer-sponsored benefit for retired employees, with a lump-sum payment or a series of payments awarded after retirement based on the employee’s salary and length of service, among other factors.

A defined-benefit plan is essentially a pension plan. The main alternative for U.S. workers is a defined-contribution plan like a 401(k) plan, which allows participants to manage their retirement savings but does not guarantee a specific income.

Key Takeaways

1. In a defined-benefit plan, the employer is committed to paying a pre-set amount owed to the retired employee.
2. The employer of a defined-benefit plan manages the retirement fund and must pay the benefits owed regardless of the returns on the money in the fund.
3. In a defined contribution plan, the employee is responsible for managing the money, given the choices of investments that the company offers.
4. The employer may or may not contribute money to a defined contribution plan.

Understanding Defined-Benefit Plans

Also known as pension plans or qualified-benefit plans, this type of plan is called “defined benefit” because the amount of the payments is pre-set based on a formula that takes into account the individual’s past salary, number of years worked, and other factors.

The employer manages the money but is responsible for paying the pensions owed, regardless of the performance of the investments in the account.

In a defined contribution plan, the amount of money available to the retiree depends on the amount in the account. As with most investments, the account balance can grow or shrink as the markets move.

Other Differences

The money in a defined benefit plan is off-limits until the employee retires. No withdrawals or loans are allowed, as with a 401(k) plan.

The company retains control of the money and pays it out according to established rules, as a lump sum or a series of payments. By contrast, employees who retire take their 401(k) accounts with them. They decide when to take withdrawals and how much.

Contributions to Defined-Benefit Plans

The employer usually funds the plan by contributing a regular amount, usually a percentage of the employee’s pay, into a tax-deferred account. This is effectively deferred compensation.

Depending on how the plan is written, employees may be able to make additional contributions to increase the eventual payout.

The plan may pay monthly payments throughout the employee’s lifetime or make a single lump-sum payment.

For example, a plan for a retiree with 30 years of service at retirement may state the benefit as an exact dollar amount, such as $150 per month per year of the employee’s service. This plan would pay the employee $4,500 per month in retirement for life. If the employee dies, some plans distribute benefits to the employee’s beneficiaries.

Important

Selecting the right payment option is important because it can affect the benefit amount the employee receives. It is best to discuss benefit options with a financial advisor.

What Is the Difference Between a 401(k) and a Defined Benefit Plan?

A defined-benefit plan, such as a pension, guarantees a certain benefit amount in retirement. A 401(k) does not.

As a defined-contribution plan, a 401(k) is defined by an employee’s contributions, which might or might not be matched by the employer.

What Are the Payout Options for a Defined Benefit Plan?

Payment options commonly include a single-life annuity, which provides a fixed monthly benefit until the retired employee’s death; a qualified joint and survivor annuity, which allows a surviving spouse to continue receiving benefits, or a lump-sum payment, which pays the entire value of the plan in a single payment.

What Is the Disadvantage to a Defined-Benefit Plan?

A defined-benefit plan’s payout is determined by a formula. That’s a guaranteed income. The employee might do better (or worse) with a 401 (k) plan, which has a greater potential upside if the money is invested wisely.

The Bottom Line

If you understand how a defined-benefit plan works, you can plan your retirement more strategically.

For example, you might choose to work a year or two longer, since length of service and final salary are factors in determining your payout.