Defined Benefit Pension Plan

Posted in Human Resources Terms, Total Reads: 1747

Definition: Defined Benefit Pension Plan

Defined benefit pension plan is actually a sum of money which is given to the retiring employee as a benefit scheme by the organization. The amount of the money to be given is calculated on the basis of some pre done calculations. A defined benefit plan is an employer sponsored retirement plan in which the employer guarantees a fixed retirement income.

The actuaries that are managing the company’s pension fund calculate the amount of contribution to be made by the employer to the fund in order to satisfy the requirements of the defined benefit pension plan. The liability of the payments to be made lies on the employer and he thus bears the risks associated with the volatility in the markets.

Importance of Defined benefit pension plan

A person dedicates his /her whole life contributing to the organization, no doubt he runs his family through the salary he gets by doing so. But it is necessary that the organization recognizes it and gives due importance to it. Defined benefit pension plans assure the employee that after he stops working for the organization, he would still have money to run his family and meet their needs. This assurance encourages the employee to work with all his mind and soul for the company. This in turn increases the productivity levels of the company, which is very much beneficial for a company to work. Also the calculation for the amount of money to be given to the retired employee is calculated on the basis of the last drawn salary, bonus, explicit contributions, number of years worked etc. These factors give back almost the equivalent amount of salary that a person used to get. The concept gives a two way benefit, first it gives assurance to employees and for the organization it helps in employer branding. The more well defined the formula for calculation of benefit plan, the more branding takes place. Benefit pension plan is a way of respecting the employees for the incomparable contribution of theirs to the growth of the company. Other types of pension plans which companies have are defined contribution pension plan, non-contributory pension plan, simplified employee pension plan etc.

Factors of Defined Benefit Pension Plan

The benefit that an employee receives as a result of the plan is a function of several factors like age, compensation, the years of service, growth in salary etc.

Defined Benefit Pension Plan

Difference Between Defined Benefit Pension Plan, Gratuity & Contribution Plan

Defined Benefit Pension Plan is different from the defined contribution plan in the way that the benefits received under defined contribution plan is subject to the investment decisions of the employee. They are not guaranteed by the employer and may not even make contributions. The benefits to be received after retirement can take many forms such as onetime payment, periodic payments etc. It is one of the major sources of income for the retirees.

Defined benefit pension plan can also be confused with the term gratuity pay, as gratuity also considers number of working years and the last drawn salary for calculating the amount to be paid as gratuity. But it is different from Defined benefit pension plan, as this is only after the retirement. Gratuity pay can be drawn at any time, if you have completed 5 working years in the same organization, to be precise 4 years 11 months.

Advantages of Defined Benefit Pension Plan

Certain advantages of a defined benefit pension plan for employees & employers are:

For employees:

1. No Investment required: The company provides all the necessary contributions. Any funding from the employee’s end is completely voluntary.

2. No decision making: Traditional retirement plans depend upon the employee’s investment. Thus they have to make sure that investment is done correctly. No such decision making is involved in case of defined benefit plan.

3. Depends upon years of service

4. In case of the employee’s death, their dependents are covered by the plan

5. No amount is deducted by employer from the employee’s regular salary

6. Cost-of-living adjustments are considered

For employers:

1. Employee retention: This plan is most effective in case of longer service tenure. This encourages employees to remain with one organization

2. Influence retirement: This plan can be used to encourage particular business strategies by proposing early retirement benefits

Disadvantages of Defined Benefit Pension Plan

Certain disadvantages of defined benefit pension plan for employees as well as employers are:

For employees:

1. No control over investment: The employees have no say over the way of investment as the company handles it

2. Fixed amount: The amount that will be received is usually predefined, thus the potential is limited. In contrast, traditional pension plans depend on the amount of investment that one can make.

For employers:

1. Most costly plan

2. Administratively complex

3. Tax applied in both cases of excess and insufficient contribution

Example of Defined Benefit Pension Plan

For example, let us consider that a person is retiring in 2019 April. He needs to be paid an amount as pension money according to the defined pension plan. So suppose he has worked for 10 years in that company and presently was drawing a salary of 1.6 lakhs per month, including some bonus and benefits the amount would be given to him. Now obviously he won’t be getting the whole salary amount. Some percentage would be given to him, but again it all depends on the calculations that an organization follows. According to that the person will be given the required amount that is, the amount would be deposited in his working account, in April 2019.

Hence, this concludes the definition of Defined Benefit Pension Plan along with its overview.

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