What is a Defined Benefit Plan?
A defined benefit plan, known as a pension, is a type of employer-sponsored retirement plan. Unlike other retirement plans, the amount of benefits a retiree receives under a defined benefit plan is predefined and depends on factors such as length of employment and salary history, rather than investment returns. The employer typically funds the plan by contributing a regular amount, partially based on actuarial calculations designed to meet the defined benefit commitment.
The implementation of a defined benefit plan bears more investment risk for the employer compared to defined contribution plans like 401(k)s, where the risk is transferred to the employee. In a defined contribution plan, the amount that the employee receives on retirement depends on the performance of the investment options that they chose.
The biggest draw to a defined benefit plan for employees is the promise of a known, predetermined benefit on retirement. No matter how investments perform, as long as the company remains solvent, the defined benefit plan guarantees a specific payout, often a percentage of the employee’s ending salary multiplied by the number of years worked.
How does a Defined Benefit Plan work?
A defined benefit plan guarantees a particular retirement benefit amount for each participant. To fund this commitment, the employer makes contributions into a pool of funds set aside for future payments. Plan assets are then invested on behalf of the participants by professional investment managers. Over time, these funds are expected to grow through investment returns, easing the financial burden on the company.
A pension is typically calculated through a formula that considers factors like length of employment, age, and salary history. The exact amount that will be received at retirement is determined and generally shared to employees. This formula essentially reduces uncertainty related to retirement income, providing peace of mind to employees.
Defined Benefit Plan and Household Capital
Household Capital is a company that offers retirement funding solutions which can be an intriguing bridge for those who do not have a defined benefit plan. Offering products like home equity-based retirement funding, Household Capital allows retirees to supplement their retirement income by making smart use of their biggest asset – their home.
Just like a defined benefit plan, using a service like Household Capital can help retirees bolster their retirement income even when the investment market is not doing well. Instead of being based on the success of their past investments, their retirement income stems from the value of their home, an asset that usually continues to gain value over time.
Final Thoughts
Certainly, a defined benefit plan is an attractive offer for employees as it promises a certain level of financial stability after retirement, reducing risk and uncertainty. However, not all employers offer such plans, and that’s where solutions like the ones offered by Household Capital can step in to fill the gap and offer stability even in turbulent times.