Which of the following is true of defined benefit plans?
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Both defined benefit (DB) and defined contribution (DC) pension plans offer various advantages to employers and employees. The features of each are generally distinct and quite different. Show Defined Benefit PlansIn a defined benefit plan, each employee’s future benefit is determined by a specific formula, and the plan provides a nominal level of benefits on retirement. Usually, the promised benefit is tied to the employee’s earnings, length of service, or both. For example, an employer may promise to pay each participant a benefit equal to a percentage of the employee’s final five-year average salary times number of years of service at retirement, or the employer may pay a flat dollar amount per year of service. A defined benefit plan is typically not contributory— i.e., there are usually no employee contributions. And there are usually no individual accounts maintained for each employee. The employer makes regular contributions to the plan to fund the participants’ future benefits. The employer bears the risk of providing the guaranteed level of retirement benefits. In 1993, 56 percent of full-time employees of medium and large private establishments were covered by defined benefit plans (U.S. Department of Labor, 1994). Defined benefit plan sponsors may choose from several formulas for determining final retirement benefits. These include:
Defined Contribution PlansIn a defined contribution plan, employers generally promise to make annual or periodic contributions to accounts set up for each employee. (Sometimes defined contribution plans are referred to as individual account plans.) The current contribution is guaranteed but not a level of benefits at retirement, as in a defined benefit plan. In 1993, 49 percent of full-time employees in medium and large private establishments participated in one or more defined contribution plans, up from 45 percent in 1988 (U.S. Department of Labor, 1994). The contribution to a defined contribution plan may be stated as a percentage of the employee’s salary and/or may be related to years of service. Sometimes there are only employer contributions, sometimes only employee contributions, and sometimes both. The benefit payable at retirement is based on money accumulated in each employee’s account. The accumulated money will reflect employer contributions, employee contributions (if any), and investment gains or losses. The accumulated amount may also include employer contributions forfeited by employees who leave before they become fully vested, to the extent such contributions are reallocated to the accounts of employees who remain. These are called forfeitures. There are several types of defined contribution plans, including money purchase plans, profit-sharing plans, 401(k) arrangements, savings plans, and employee stock ownership plans (ESOPs). These are described briefly below. (For more detail, consult individual chapters on these plans.) Employee Benefit Research Institute, 1997 The Employee Retirement Income Security Act (ERISA) covers two types of retirement plans: defined benefit plans and defined contribution plans. A defined benefit plan promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact
dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service - for example, 1 percent of average salary for the last 5 years of employment for every year of service with an employer. The benefits in most traditional defined benefit plans are protected, within certain limitations, by federal insurance provided through the Pension
Benefit Guaranty Corporation (PBGC). A defined contribution plan, on the other hand, does not promise a specific amount of benefits at retirement. In these plans, the employee or the employer (or both) contribute to the employee's individual account under the plan, sometimes at a set rate, such as 5 percent of earnings annually. These contributions generally are invested on the employee's behalf. The employee will ultimately receive the balance in their account, which is based on
contributions plus or minus investment gains or losses. The value of the account will fluctuate due to the changes in the value of the investments. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans. A Simplified Employee Pension Plan (SEP) is a relatively uncomplicated retirement savings vehicle. A SEP allows employees to make contributions on a tax-favored basis to individual retirement accounts (IRAs) owned
by the employees. SEPs are subject to minimal reporting and disclosure requirements. Under a SEP, an employee must set up an IRA to accept the employer's contributions. Employers may no longer set up Salary Reduction SEPs. However, employers are permitted to establish SIMPLE IRA plans with salary reduction contributions. If an employer had a salary reduction SEP, the employer may continue to allow salary reduction contributions to the plan. A Profit Sharing Plan or Stock Bonus Plan is a
defined contribution plan under which the plan may provide, or the employer may determine, annually, how much will be contributed to the plan (out of profits or otherwise). The plan contains a formula for allocating to each participant a portion of each annual contribution. A profit sharing plan or stock bonus plan may include a 401(k) plan. A 401(k) Plan is a defined contribution plan that is a cash or deferred arrangement. Employees can elect to defer receiving a portion of their salary
which is instead contributed on their behalf, before taxes, to the 401(k) plan. Sometimes the employer may match these contributions. There is a dollar limit on the amount an employee may elect to defer each year. An employer must advise employees of any limits that may apply. Employees who participate in 401(k) plans assume responsibility for their retirement income by contributing part of their salary and, in many instances, by directing their own investments. An Employee Stock Ownership
Plan (ESOP) is a form of defined contribution plan in which the investments are primarily in employer stock. A Cash Balance Plan is a defined benefit plan that defines the benefit in terms that are more characteristic of a defined contribution plan. In other words, a cash balance plan defines the promised benefit in terms of a stated account balance. In a typical cash balance plan, a participant's account is credited each year with a "pay credit" (such as 5 percent of compensation from his
or her employer) and an "interest credit" (either a fixed rate or a variable rate that is linked to an index such as the one-year treasury bill rate). Increases and decreases in the value of the plan's investments do not directly affect the benefit amounts promised to participants. Thus, the investment risks and rewards on plan assets are borne solely by the employer. When a participant becomes entitled to receive benefits under a cash balance plan, the benefits that are received are defined in
terms of an account balance. The benefits in most cash balance plans, as in most traditional defined benefit plans, are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC). Web Pages on This TopicCash Balance Plans: Questions and Answers (PDF) - Provides answers to commonly asked questions about cash balance plans. Consumer Information on Retirement Plans - Publications and other materials providing information about your rights as retirement plan participants under federal retirement law. Compliance Assistance - Provides publications and other materials designed to assist employers and employee benefit plan practitioners in understanding and complying with the requirements of ERISA as it applies to the administration ofemployee pension and health benefit plans. Choosing a Retirement Solutions for Your Small Business (PDF) - Provides information about retirement plan options for small businesses. ERISA Filing Acceptance System (EFAST2) - EFAST2 is an all-electronic system designed by the Department of Labor, Internal Revenue Service, and Pension Benefit Guaranty Corporation to simplify and expedite the submission, receipt, and processing of the Form 5500 and Form 5500-SF. QDROs: The Division of Retirement Benefits through Qualified Domestic Relations Orders (PDF) - QDROs are domestic relations orders that recognize the existence of an alternate payee's right to receive benefits payable to a participant under a retirement plan. This publication provides questions and answers on QDROs. Retirement and Health Care Coverage: Questions and Answers for Dislocated Workers (PDF) - Provides answers to commonly asked questions from dislocated workers about their retirement and health plan benefits. SIMPLE IRA Plans for Small Businesses (PDF) - Provides information about the basic features and requirements of SIMPLE IRA plans. SEP Retirement Plans for Small Businesses (PDF) - Describes an easy, low-cost retirement plan option for employers. Understanding Retirement Plan Fees And Expenses (PDF) - Provides information about plan fees to help you evaluate your plan’s investment options and prospective providers. 401(k) Plan Fees Disclosure Tool - Model comparative chart for disclosures to participants of performance and fee information to help them compare plan investment options. What You Should Know About Your Retirement Plan (PDF) - Provides information to help answer many of the most common questions about retirement plans. Your Employer's Bankruptcy: How Will it Affect Your Employee Benefit? (PDF) - Provides information on bankruptcy's effect on retirement plans and group health plans. What is true about a defined benefit plan?A defined benefit plan, more commonly known as a pension plan, offers guaranteed retirement benefits for employees. Defined benefit plans are largely funded by employers, with retirement payouts based on a set formula that considers an employee's salary, age and tenure with the company.
Which of the following is true about a defined benefit plan quizlet?Which of the following statements is TRUE of a defined benefit plan? Under a defined benefit plan, the amount of retirement benefit is fixed and the employee knows the amount.
What are the characteristics of a defined benefit plan?A DB plan is primarily insurance against lost income due to retirement, death, or disability. A benefit specified by a formula is promised. This formula will precisely specify the benefit based on the age, service, and pay of the member. A DC plan is primarily a savings vehicle.
What is a defined benefit plan quizlet?Defined Benefit Plan. An employer-sponsored retirement plan where employee benefits are sorted out based on a formula using factors such as salary history and duration of employment.
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