Defined Benefit Pension Plans are the traditional pension plans where both you and your employer withhold a certain amount of your gross wage, manage it until retirement and this guarantees you a specified monthly income for life, upon your official retirement. The total monthly payment you will receive depends on how long you have worked, and how big your pension nest egg is.
Upon your retirement, you will receive monthly annuity payments for life (until your death). Monthly annuity payments are NOT the only way to receive your money, you could elect to receive a lump sum rollover of your retirement savings.
Spouse and Defined Benefit Plans
If you invest in a defined benefit plan, you must officially arrange whether the pension benefits will cover you alone, or you and your spouse. If you choose the “Me & My Spouse” option, your spouse will continue to receive your pension annuity payments even after your death. However, if you choose just yourself, then the monthly annuity payments each month will be greater.
Safety of Defined Benefit Plans
Your defined benefit pension plan is insured by the Pension Benefit Guarantee Corporation (PBGC) which is an agency of the government. Incase of any default, the PBGC will cover your pension payments by a certain percentage. This may not always be 100%.
Cash Balance Plans – Defined Benefit Plans
Cash Balance Plans are a new type of Defined Benefit Pension Plans and many employers are now converting their traditional defined benefit plans into cash balance plans. With Cash Balance Plans, your employer will contribute Payment Credits and Interest Credits towards your account each year. The exact amounts that will be contributed depend on your gross salary and benefits you receive.
How Cash Balance Plans Work
Cash Balance Plans take into account your salary only. The # of years of employment you have had does not matter. Your employer will make cash distributions to your account at the end of each year and you do not have to worry about getting an investment advisor to handle your account. Your employer will handle it for you. Your employer is responsible for any investment risks and losses.
Who would choose Cash Balance Plans? Younger employees who have entry-level jobs and not many years of work experience will benefit from the cash balance pension plans because the amount of contributions is based solely on your salary, not your length of employment history or age.
Vesting and Defined Benefit Plans
Almost all defined benefit plans require you to “vest” the # of years you work before you are eligible for defined benefit pension plan payments. For example, some 401k vesting plans will require you to work a minimum of 4 years before your benefits are vested 100%. Therefore, if you leave the company in Year 3, you get NONE of the benefits. However, if you leave in year 5, you get all of the benefits. There are 2 types of 401k vesting:
1) Cliff Vesting
Cliff Vesting is when vesting of 401k retirement accounts occurs all at once, rather than a gradual phased out period of time. Instead of a percentage of your employer’s 401k match-up contributions being vested over a phased out period of time, the vesting will occur all at once after a certain period of time, e.g 5 years… (Read More about Cliff Vesting)
2) Graded Vesting
Here is a 401k Vesting Schedule set by the Employee Retirement Income Security Act (ERISA) as a minimum guideline both for 401k contributors and employers.
401k Vesting Guideline Schedule 1 set by ERISA
|Years of Work Vested||Percentage of Accrued Benefits Vested|
|Less than 3||0%|
|Atleast 3, but not >4||20%|
|Atleast 4, but not >5||40%|
|Atleast 5, but not >6||60%|
|Atleast 6, but not >7||80%|