In the area of employee benefits, Defined Benefit (DB) pensions stand out as a cornerstone of retirement planning. These plans, often referred to simply as pensions, promise a specified monthly benefit upon retirement, which is predetermined by a formula based on the employee's earnings history, years of service, and age. This article is a high-level summary of Defined Benefit pensions, comparing them to Defined Contribution (DC) retirement plans, and highlighting the unique advantages offered by the Alight Benefits Advantage.
What is a Defined Benefit pension?
A Defined Benefit pension plan is an employer-sponsored retirement plan in which the benefits are calculated using a specified formula. This formula typically includes the employee's salary, years of service, and age at retirement. It provides a predictable income for retirees.
Unlike DC plans, such as 401(k)s, in which the retirement benefit depends on the investment performance of the contributions made by the employee and the employer, if the employer provides a match or a profit-sharing component, DB plans provide a guaranteed fixed payout upon retirement in either a lump sum or as a monthly annuity benefit payment.
How Defined Benefit pensions work
In a Defined Benefit pension plan, the employer makes contributions per governmental required minimum funding rules to a pension plan trust fund, which is invested to grow over time. Upon retirement, the employee receives a monthly benefit payment, which is calculated based on the predetermined formula.
Advantages and disadvantages of Defined Benefit pensions
- Predictable retirement income: Employees can plan their retirement with confidence, knowing exactly how much money they will receive each month.
- Employer-funded: The employer is responsible for funding the plan, which can be a significant advantage for employees who may not have the means to contribute to a DC plan such as a 401(k) savings plan.
- Rewards loyalty: Defined Benefit pension plans often reward long-term employees, as the benefit amount increases with years of service.
In recent years, the popularity of Defined Benefit pension plans has declined despite efforts to address the portability and communication challenges (e.g., cash balance plan designs, which communicate a balance in today’s dollars). Several factors contributed to this trend, including:
- Financial burden: The increasing cost of maintaining such plans for employers has made them less attractive, particularly as people live longer.
- Market fluctuations: Guaranteeing these benefits amidst fluctuating market conditions poses significant funding challenges.
- Difficulty understanding the value of a DB plan: Employees often struggle to understand the value of a future monthly benefit that’s payable at, typically, age 65.
- Employees want more choices: Many employees favor DC plans that offer them greater control over their retirement savings and investment choices.
This shift reflects a broader move towards individual responsibility for retirement planning.
Comparison with DC plans
Defined Contribution plans, such as 401(k)s, differ significantly from Defined Benefit pensions. In a DC plan, the employee, and sometimes the employer, make regular contributions (an employer match) to an individual account. The retirement benefit depends on the investment performance of these contributions, which means the employee bears the investment risk. Defined Contribution plans offer flexibility and portability but generally don’t provide the guaranteed monthly income provided by Defined Benefit pensions.
The Alight Benefits Advantage and DB plans
The Alight Benefits Advantage offers a unique approach to managing Defined Benefits pensions. With Alight’s Defined Benefit Administration services, organizations and their employees can fully understand their pension options. Our Alight Worklife® platform ensures that essential plan information is easy to manage, access, and navigate. It offers self-service options, education, and access to experts who are always ready to help.
By leveraging Alight Worklife, HR professionals can streamline the administration of Defined Benefit pensions, assisting employees to retire with confidence and peace of mind. Alight’s sophisticated pension plan administration helps organizations provide a seamless and supportive experience for their employees, making it a valuable partner in the realm of benefits administration.
Despite their decreased popularity as a retirement benefit, pensions remain a vital component of planning for a secure retirement income. By partnering with Alight, organizations can enhance their benefits administration, providing employees with the support and resources they need to confidently navigate their retirement journey.
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