Definition · Compensation and benefits
Defined Benefit Plan
Definition
A defined benefit plan is a retirement plan that promises a set income in retirement, usually based on salary and years of service, with the employer carrying the investment risk. A defined contribution plan, such as a 401(k), defines what goes into an account instead, and the employee's balance depends on contributions and investment returns.
Also called: DB plan, Pension plan, Traditional pension
Formula
Annual pension = Benefit multiplier × Years of service × Final average pay
- Benefit multiplier
- The percentage set in the plan document, often between 1% and 2% per year of service.
- Years of service
- Credited years under the plan's service rules, which may cap the total.
- Final average pay
- Average pay over a defined window, commonly the highest or last three to five years.
Worked example
Maria retires after 25 years with a plan multiplier of 1.5% and final average pay of $68,000. Annual pension = 1.5% × 25 × $68,000 = $25,500 a year, or $2,125 a month for life under the standard payment form.
Defined benefit vs defined contribution: the core difference
The names describe what is fixed. In a defined benefit plan the benefit is defined, so the employer must fund enough to pay it, whatever markets do. In a defined contribution plan the contribution is defined (for example, a 4% employer match into a 401(k)), and the final balance is the employee's to manage.
- Investment risk: employer in DB; employee in DC.
- Portability: DB benefits reward long tenure and are often worth little to someone who leaves after five years; DC balances move with the employee once vested.
- Cost predictability: DB costs swing with interest rates and returns; DC costs are a known percentage of payroll.
- Insurance: most private-sector DB plans are insured up to limits by the Pension Benefit Guaranty Corporation (PBGC); DC accounts are not, because there is no promised benefit to insure.
Both are governed by ERISA in the private sector, with reporting, fiduciary and vesting rules.
Where defined benefit plans still show up
Private-sector employers have largely closed or frozen traditional pensions in favor of 401(k) plans. DB plans remain common in state and local government (teachers, police, transit), in many unionized workforces through multiemployer plans negotiated in collective bargaining, and in some utilities and large legacy employers.
A middle option is the cash balance plan. Legally it is a defined benefit plan, but each employee sees a hypothetical account that grows by a pay credit and an interest credit, which makes it easier to explain.
What it means for recruiting and retention
A pension is a retention tool built for long careers. Because benefits grow fastest in the final years, mid-career employees in a DB plan rarely leave, which helps public agencies and utilities keep experienced staff. The same design does little for a 24-year-old comparing two offers, who will usually value a visible 401(k) match more than a benefit 40 years away.
Recruiters for organizations with a pension should explain it in plain numbers: "after 20 years, a typical employee at this salary retires with about $X a month." Candidates coming from DC-only employers often underestimate what a pension is worth. For lateral hires, also explain vesting: a five-year cliff means someone who leaves in year four gets nothing from the plan.
Common misunderstandings
"Pension" and "defined benefit" are often used as synonyms, but some people call any retirement plan a pension. Frozen DB plans still have obligations to existing participants even though no one new joins. And a DB plan does not stop employees from saving in a DC plan; many public employers offer both. Plan rules vary by employer and state retirement system, so quote from the actual plan document.
Frequently asked questions
What is the main difference between defined benefit and defined contribution plans?
A defined benefit plan promises a set retirement income and the employer carries the investment risk. A defined contribution plan sets how much goes into an account, and the employee's retirement income depends on contributions and returns.
Is a 401(k) a defined benefit plan?
No. A 401(k) is a defined contribution plan. The employee owns an individual account balance rather than a promised monthly benefit.
Is a pension plan the same as a defined benefit plan?
Usually yes. A traditional pension is a defined benefit plan that pays a monthly amount for life based on a formula of pay and service.
Who insures defined benefit plans?
Most private-sector defined benefit plans are insured by the PBGC up to legal limits. Government plans are not covered by the PBGC and depend on the sponsoring government.
Which is better for employees?
It depends on tenure. Long-tenured employees often get more security from a defined benefit plan, while people who change employers every few years usually do better with a portable defined contribution plan.