Defined Benefit Plans
In a defined benefit plan, the employer bears the investment risk. While defined contribution plans reward the employee based on the investment returns, the defined benefit plan provides a specific benefit based on service and income. As a result, the company may be required to make additional funding to fulfill the payment to the employee if there is a shortfall in the investments’ returns.
The maximum benefit in a defined benefit plan surpasses those allowed in a defined contribution plan and can therefore be a powerful savings and deduction tool either on its own or tested in conjunction with a defined contribution plan. They can be a unique tool for quickly accumulating retirement funds.
In combination, a defined plan and defined contribution plan can enable the sponsor to cost effectively increase savings while maintaining some flexibility. This combination can provide key employees with much larger contributions than allowed in a defined contribution plan alone and the combined testing with the defined contribution plan enables flexibility and cost savings.
Instead of determining contributions, and investing them to produce the greatest possible benefit, the traditional defined benefit plan defines a specific monthly benefit at retirement, and determines appropriate contributions to fund the benefit. The document can be written to provide different classes of employees different monthly retirement benefits (e.g. a higher formula to key employees).
A cash balance plan is designed to combine the increased funding available in a traditional defined benefit plan with the straightforward presentation of a specific allocation in the defined contribution plan. The benefit is expressed as an annual allocation and individual account rather than a monthly pension payable at retirement. The plan may be structured to provide different allocations to different classifications of employees. This format is much easier for employees to understand and appreciate than a traditional defined benefit plan.