While the trend has been shifting to defined contribution plans, millions of American workers continue to depend on traditional defined benefit pension plans in retirement. These plans typically are funded entirely by the employer, who bears the investment risk. Such plans, which are guaranteed by the federal government, base benefits, on length of service and salary (as a percentage of pre-retirement pay).
Generally, an employee is eligible if he or she is 21 or older, has been employed for one year, and works at least 1,000 hours a year for the sponsoring employer (employers may waive these requirements). Part-time employees usually are not eligible.
A type of defined benefit plan is a cash balance plan. In a typical cash-balance plan, your employer contributes a set amount of money—for example, perhaps 5 percent of your salary—to an account each year. Your employer also guarantees that your account will grow at a certain rate every year. That rate may be either a fixed amount or a variable rate tied to a benchmark, such as the one-year Treasury bill.
When you leave your job or retire, you can take your balance in a lump sum and roll it into an individual retirement account (IRA). Alternatively, you can choose an annuity that will provide a guaranteed monthly payment for the rest of your life.
A worker vested under a defined benefit plan may enjoy a number of advantages, including:
Guaranteed monthly payments for life through a pension annuity. Workers typically know in advance the amount of this retirement benefit.
Additional benefits such as early retirement, disability benefits, and cost-of-living adjustments.
Dependent Protection in the form of a joint and survivor annuity, which provides regular payments to your spouse after you die. These payments are paid automatically unless you and your spouse elect otherwise in writing.
If you waive this option and choose a life annuity in which you receive payments until your death, no payments will be made to your spouse after you die. Although monthly payments are larger under the life annuity option, make sure your spouse is able to survive financially without relying on your pension before making this choice.
Understanding Your Defined Benefit Plan
Under a defined benefit pension plan, retirement benefits are based on salary and length of employment. Some questions to ask might include:
What are the eligibility requirements?
When do my benefits become vested? That is, when do the benefits belong to you even if I leave my job?
What benefits will my spouse receive if I die before reaching retirement? After retirement?
How is the amount of my pension calculated? Is it adjusted for inflation?
How will my pension be affected if I retire early, or continue working past age 65?
How will my pension be affected if I take an extended leave of absence from my job?
Publications and Resources
401(k) Fee Disclosure Form. ACLI, working with the American Bankers Association and the Investment Company Institute, developed a 401(k) Fee Disclosure Form designed to assist companies in making informed cost-benefit decisions when selecting 401(k) service providers.