Characteristics of a defined benefit pension plan
In a defined benefit pension, the amount of the pension is set in advance according to a specific formula. The formula generally corresponds to a percentage of pay multiplied by the years of service recognized by the plan.
Here's an example:
The pay used to calculate the pension is 40 000 $
The member have 25 years of service
The plan grants a pension of 2% of pay for each year of credited service
2 % × 40 000 $ × 25 = 20 000 $
The member's pension will therefore be 20 000 $ a year.
The majority of workers who have a pension plan are members of a defined benefit plan.
Who assumes the risk?
The risks related to funding the plan are mainly assumed by the employer.
If the pension fund's assets are insufficient to pay all the pensions and other benefits provided for by the plan, the employer must pay the difference.
The pension fund
The pension fund includes the employer contributions and the member contributions (if the members are required to contribute).The fund is the plan's "bank account". Unlike a defined contribution plan, the employer contributions are not distributed among the members' accounts.
What happens when a member retires?
If the member uses his or her transfer right, he or she can:
- use a life income fund (LIF) to draw a retirement income or to purchase a life annuity from an insurer. In the case of an annuity, the member can begin receiving payments immediately or at a latter date, as desired.
- first use other sources of income before drawing his or her retirement income by leaving his or her retirement savings in a locked-in retirement account (LIRA) where they will continue to grow.
If a member does not exercise his or her transfer right, a pension will be paid to him or her by the plan.