Defined Benefit

Lesson

Defined benefit plans are a type of qualified retirement plan which provide a specific benefit to employees upon retirement based on factors such as years of service and salary. Employer contributions fund these plans and are subject to strict regulations under the Employee Retirement Income Security Act (ERISA).

Practice Question #1

Which of the following is a characteristic of a defined benefit plan?

A) Employer contributions are based on a percentage of company profits.

B) The final benefit depends on the performance of the investments.

C) Employees make pre-tax contributions through payroll deductions.

D) The benefit is based on factors such as years of service and salary.

Select an option above to see an explanation here.

A) This is a characteristic of a profit-sharing plan. B) This is a characteristic of a defined contribution plan. C) This is a characteristic of a 401(k) plan. D) This is a characteristic of a defined benefit plan.

Terms

Defined Benefit Plan:: A type of qualified retirement plan that provides a specific benefit to employees upon retirement based on years of service and salary.
ERISA:: The Employee Retirement Income Security Act sets minimum standards for pension plans in private industry.
Funding:: The process of making contributions to a retirement plan to provide benefits for plan participants.

Practice Question #2

What is the primary federal law governing defined benefit plans?

A) The Internal Revenue Code

B) The Employee Retirement Income Security Act (ERISA)

C) The Pension Protection Act

D) The Social Security Act

Select an option above to see an explanation here.

A) The Internal Revenue Code contains provisions related to the tax treatment of retirement plans but is not the primary law governing them. B) ERISA sets minimum standards for pension plans in private industry, including defined benefit plans. C) The Pension Protection Act changed pension funding rules but is not the primary law governing them. D) The Social Security Act established the Social Security program, separate from private pension plans.

Do Not Confuse With

Defined Contribution Plan:: A type of qualified retirement plan where the employer makes contributions to individual accounts for each employee, and the final benefit depends on the performance of the investments.
401(k) Plan:: A defined contribution plan allowing employees to make pre-tax contributions through payroll deductions.
Simplified Employee Pension (SEP) Plan:: A type of retirement plan for small businesses that allows employers to contribute to individual retirement accounts for employees.

Practice Question #3

Which of the following is NOT a type of defined contribution plan?

A) 401(k) Plan

B) Profit-Sharing Plan

C) Simplified Employee Pension (SEP) Plan

D) Joint and Survivor Annuity

Select an option above to see an explanation here.

A) A 401(k) plan is a defined contribution plan. B) A profit-sharing plan is a type of defined contribution plan. C) A SEP plan is a type of retirement plan for small businesses, a defined contribution plan. D) A joint and survivor annuity is a type of annuity that provides benefits to both the employee and their spouse upon retirement, which is a feature of defined benefit plans.

Historical Example

In the 1980s, many companies shifted from defined benefit plans to defined contribution plans, as the latter offered employers more flexibility and cost control. This trend was widely reported in major newspapers, as it marked a significant change in how companies provided retirement benefits to their employees.