A defined benefit plan provides a specified level of benefit upon retirement, in contrast to a defined contribution plan that merely provides an account balance.  A defined benefit plan can be effective in rewarding long-service employees.  It can also be helpful in attracting experienced workers because the benefit becomes more valuable the closer an employee is to retirement age.  Employees receive lifetime protection if benefits are received as an annuity, whereas defined contribution plans often do not offer annuities as a distribution option.

A 2011 study commissioned by the New York City Controller found that it is 57% – 61% more expensive to provide comparable benefits in a defined contribution plan than if those benefits were provided in a defined benefit plan.

Small employers can design a defined benefit plan to maximize the owner’s benefits and tax deduction, making a defined benefit plan an effective tax-planning tool.

The contribution requirements are determined each year by the plan’s actuary to ensure that sufficient assets will be available to pay plan benefits as they become due many years in the future.  As a result, contributions will fluctuate, due to investment return fluctuations and varying interest rate levels, and cannot be determined by the plan sponsor without the assistance of an actuary.  This cash flow uncertainty is a disadvantage of defined benefit plans.

The plan sponsor bears the investment risk.  In a strong investment market, the sponsor enjoys the favorable investment return.  However, in a weak market, higher contributions will be required to compensate for lower-than-expected investment return.

This article was last updated on October 28, 2011