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The Curious Bag
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A defined benefit pension plan is a tax-qualified plan that provides participant a fixed benefit based on age, service and salary. The investment risk is borne by the employer, or sponsor, of the plan.
Features
Pension plan assets are invested by the employer and the benefit you receive is independent of investment performance. This is the opposite of a defined contribution 401(k) plan.
Types
There are two types: a traditional plan and a cash balance plan. The benefits are similar, although calculated differently. A traditional plan's benefits are typically shown as a monthly amount payable for life. With a cash balance plan your benefit is presented as a lump sum balance like a 401(k) plan.
Distributions
Traditional pension distributions usually come in the form of an annuity, payable for life of some fixed term which may include payments to a beneficiary.
Taxes
Pension annuity distributions are treated as income and ordinary income taxes are due based on your individual tax bracket.
Considerations
A defined benefit pension plan provides guaranteed income in retirement. However, it typically does not increase with inflation, so in real terms the benefit decreases somewhat over time.
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