With this plan, the benefits an employee will receive are predetermined by a specific formula -- typically calculated by an actuary annually. The promised benefit is tied to the employee's earnings, length of service or both. The employer is responsible for making sure that the funds are available when needed (the employer bears funding and investment risks of the plan).
Defined benefit plans are typically better for older employees (usually age 45+). For example, these plans can provide the ability to fund for years of employment before the inception of the plan. While some contribution flexibility is available, factors determining the cost of promised benefits (e.g., number and ages of employees, rates of return on investments) will mandate the level of required deposits to the plan.
The price of providing a higher degree of tax savings and being able to rapidly shelter larger sums of retirement capital is having to meet additional reporting requirements. Defined benefit plans typically cost more to administer, requiring certifications by enrolled actuaries, and approval of terminations by both the IRS and the Pension Benefit Guaranty Corporation (PBGC).
