A defined benefit plan, also called a pension, is a workplace benefit that pays you a fixed amount regularly after retirement as long as you meet certain requirements.
About 86% of state and local government workers and 15% of all private industry workers have access to a defined benefit plan, also called a pension.
What is a defined benefit plan and how does it differ from other retirement plans like a 401(k) and individual retirement accounts (IRAs)? Let’s take a look.
Defined benefit vs. defined contribution plans and IRAs
In general, there are two types of retirement plans you may have through an employer: a defined contribution (DC) plan and a defined benefit (DB) plan.
A DC plan—commonly referred to as a 401(k)—allows you to contribute a percentage of pre-tax income to retirement savings. In the case of a DC plan, your employer may also add to your savings, typically in the form of a match of some or all your contribution. (An IRA is also funded with pre-tax income, but not offered through an employer; it's funded by you.) When you reach retirement, you decide how much to withdraw from year to year from both an IRA and a 401(k).
A defined benefit plan, on the other hand, is created for you and funded entirely by your employer. You’re not required to make contributions, although some plans may allow it. Another key difference between DB and DC plans? A DB or pension pays out a set amount to in retirement, for the entire length of that retirement.
| Defined benefit plan | Defined contribution plan | |
|---|---|---|
| Also called | Pension | 401(k), 403(b) (two examples) |
| Funded by | Employer (unless employee contributions are allowed by the plan) | Employee and employer (if a match is available) |
Who is eligible for a defined benefit plan?
Your employer determines eligibility for a defined benefit plan. Most require a certain number of years of employment, such as two or three. Some may offer the plan to both full- and part-time employees.
How is a defined benefit payout calculated?
Most calculations use years of service—how long you work at an employer—and annual salary. In general, the greater your salary or longer your service, the greater your benefit.
What do you receive after retirement from a defined benefit plan?
Much like a 401(k) plan, you will receive a payout (see below for details) after you retire.
Is every defined benefit plan the same?
No. Defined benefit plans differ from employer to employer. There may be different service calculations or different payout options, for example.
What are the options for defined benefit payout?
Every plan has a monthly payout option; beyond that, your employer can choose to offer additional payout options. Those may include:
| Defined benefit payout option | Details |
|---|---|
| Life annuity, or straight life | The most common type of payout, this one gives you the same payout every month until you die. Most DB plans pay a monthly benefit. |
| Lump sum | You choose a single payout of your entire available benefit. Plan provisions determine where the funds can be deposited and what taxes may apply. |
| Certain and life, or continuing coverage (CC) | You choose a certain period, such as 10 years, to receive guaranteed payments. If you live longer, you continue to receive the payments. If you die before that period ends, your beneficiary receives the payments for the remainder of the period or a lump sum (if allowed). |
| Survivorship | You receive a monthly income for the rest of your life. You choose a percentage of that income, such as 50%, which goes to your beneficiary for the rest of his or her life. |
| Social Security adjustment | If you retire before age 62, this plan provides a larger DB benefit, and thus a larger level income. When you reach Social Security retirement age, your DB payout is reduced by the amount of Social Security. |
Are defined benefit plan payouts taxed?
Yes. Your payouts will be taxed as part of your normal retirement income. To learn more, read “What you should know about defined benefit (DB) plans.â€
Does Social Security affect defined benefit plan payouts?
It depends on the type of defined benefit plan you’re enrolled in. For more details, read “How does a defined benefit plan work with other retirement savings?â€
What’s next?
If you have a defined benefit plan serviced by Principal, you can check on estimated benefit and more by . First time logging in? Get started by creating an account. Want to supplement your employer retirement savings? We can help you set up your own retirement account.
