A defined benefit (DB) plan is a traditional pension plan in which the employer promises to pay retirees a specific monthly benefit, typically calculated using a formula based on salary, years of service, and age.
Benefit formula (common example): > Monthly benefit = 1.5% × years of service × final 3-year average salary
A 30-year employee earning $80,000 average = 1.5% × 30 × $80,000 = $36,000/year ($3,000/month).
Key characteristics:
| Feature | DB Plan | DC Plan (401k) | |---|---|---| | Benefit | Defined/guaranteed | Based on account balance | | Investment risk | Employer bears | Employee bears | | Funding responsibility | Employer | Employee (+ employer match) | | PBGC coverage | Yes | No |
PBGC: Pension Benefit Guaranty Corporation — a federal agency that insures DB plan benefits up to a cap if the sponsoring employer goes bankrupt. Max guarantee: $7,107.95/month (2024) for workers retiring at 65.
Actuarial assumptions: DB plans rely on actuaries to estimate future liabilities (investment returns, mortality, turnover assumptions). Underfunded plans are a major risk.
ERISA requirements: Vesting (cliff or graded), minimum funding rules, participant disclosures, PBGC premiums.
Lump-sum option: Many DB plans offer a lump-sum payout at retirement in lieu of the annuity; the decision involves interest rate risk and longevity risk tradeoffs.
> Exam tip: DB plan = employer bears the investment risk. DC plan (401k) = employee bears the investment risk. For the CFP® exam, know lump-sum vs. annuity analysis and PBGC coverage limits.