Defined Benefit Plans Made Simple: Secure Your Pension the Smart Way

A Defined Benefit Plan is a type of pension plan where an employer pays a certain amount to their employees on their retirement. This amount is calculated by using a formula which takes into consideration the number of years of service, the employee’s salary, & the age of the employee at the time of retirement. Hence, “Defined” here means the benefit to be received is guaranteed & can be calculated using a well-defined formula. This plan offers guaranteed benefits without worrying about how investments would be managed.

How Does a Defined Benefit Plan Work?

Under this plan, an employer contributes to make the corpus amount equal to the promised retirement benefits.This accumulated amount will then be received by an employee at the time of their retirement in the form of a payout. This benefit amount is calculated using a pre-defined formula, taking into consideration the salary of the employee & the duration of employment with the organisation.

Let us take an example of an employee, Mr. X, in an organisation for 30 years that has been providing a defined benefit plan. The average salary for the last 5 years is INR 8,00,000. The formula used to calculate the retirement benefit is as mentioned below:

= 2% of the average of the last 5 years of salary multiplied by the number of years worked.

= 0.02 * 8,00,000 * 30

= INR 4,80,000 per annum

What are the Defined Benefit Plan Payment Options?

Provided are the different options offered by the Defined Benefit Plan:

Single Life Annuity

This plan is meant for those individuals without dependents who want their monthly income to be increased. It covers a single individual, i.e., a retiree only, where no payment would be offered to the dependent survivors of the policyholder.

Lump-Sum Payments

This offers a benefit amount in a lump sum to the retiree, which provides flexibility in case of personal investments, etc. This includes prompt financial management, avoiding the premature depletion of funds.

Qualified Survivor & Joint Annuity

Under this plan, a qualified survivor, mostly a spouse, will receive the benefit amount after the death of the retiree. This type offers a lesser amount of benefit in comparison to a single life annuity plan, still offering financial security to the retiree’s dependents.

Difference Between a Defined Benefit Pension Plan &a Defined Contribution Plan

Basis of Difference	Defined Contribution Plan	Defined Benefit Plan
Portability	In case an employee leaves the company, they are allowed to take their balances along with them.	No portability, as a lump sum amount is offered as the benefit amount.
Benefit Structure	Under this plan, a regular contribution amount is invested & left to grow. This amount accumulated as a corpus is then used for the final payout.	This plan offers a lump sum amount to be received at the time of retirement.
Investment Risk	As the performance of investments decides the amount of payout, employees in this case bear the risk.	As the prime responsibility lies with the employer to contribute the funds & meet obligations, the employer only bears the investment risk.
Contributions	Under this plan, the employer may contribute, but the primary responsibility to contribute lies with the employee.	Under this plan, the prime responsibility lies with the employer to contribute.

Types of Defined Benefit Plans in India

Provided are the different types of Defined Benefit Plans in India:

Pensions

Pension is a form of defined benefit plan, where an employer offers a monthly benefit amount to the employees post-retirement. This calculation is made considering certain factors, like salary, number of years of service, etc.

Cash Balance Plans

Under this plan, the account is maintained by the employer’s contribution, which is a certain percentage of the salary amount. Here, the cash balance keeps on accumulating along with the interest amount till the employee’s retirement.

Whenever an employee retires, he is provided an option to choose to receive their account balance as a lump sum or annuity.

Benefits of a Defined Benefit Plan

Provided are the benefits of the Defined Benefit Plan:

Secure Retirement

This plan offers employees a guaranteed income source post-retirement, providing them with financial security & mental peace. This pension amount can be calculated using the pension calculator depending on the history of salary &the number of years served.

Improved Retention for the Employer

As the contribution in this plan is made by the employer, ensuring employees’ financial security post-retirement with enough funds is crucial. In return, employees work with dedication & commitment when they feel cared for & well-identified.

Risk Management

This plan helps both the employer & the employee.The employer is involved in investing & managing funds. In case there is a shortfall of funds, it is only the employer’s responsibility, & not the employees.

Retirement Planning

Employees can plan their retirement easily when they have an understanding of the plan. This means they can plan their future well by knowing the amount that will be received post-retirement in advance.

Financial Cover for Spouse

It not only includes employees, but also their spouses. This means that in case of an unfortunate event, such asthe sudden demise of an employee, the partner will receive a certain amount of benefits.

Tax Benefits for the Employer

It allows for tax benefits on the amount of contribution made by the employer.

Conclusion

Employers manage defined benefit plans as they contribute to the fund, taking into consideration factors such as employees’ income, age, number of years of service, etc. The employer undertakes the responsibility of investing & managing the funds & offers employees a guaranteed source of income post their retirement. This plan is beneficial in terms of tax advantages, predictable payouts, benefits for spouses, etc, but there are disadvantages as well. They include the risk of losing buying capacity because of inflation &a lack of flexibility.

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Adam Regan

Deputy Editor

Features and account management. 3 years media experience. Previously covered features for online and print editions.

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