The one thing no defined contribution can offer is a guaranteed retirement income benefit. For that, a businessowner must select a defined benefit plan.
Traditional Defined Benefit Plans
There are three traditional types of defined benefit pension plan, each one differentiated by the formula that is used to determine the benefit to be paid to participants at retirement. Regardless of the benefit formula used, determinable retirement benefits are provided at some future point in time, as stated in the defined benefit plan. The three traditional methods are:
- Fixed Benefit Formula
— Each participant receives a flat benefit at retirement, such as $100 per month, regardless of salary or length of service.
- Percentage Benefit Formula
— Each participant receives a percentage of salary at retirement. For example, if each participating employee is entitled to receive a benefit of 15 percent of salary at retirement, an employee earning $2,000 per month will then be guaranteed to receive a monthly retirement benefit of $300, while an employee earning $8,000 per month will receive a $1,200 monthly retirement benefit.
- Unit Benefit Formula
— A unit benefit formula takes both salary and length of service into account. For example, each participant could receive a retirement benefit equal to 1/2 percent of salary, times years of service. An employee with 10 years of service will then receive a retirement benefit of five percent of salary (1/2 percent x 10 years), while an employee with 40 years of service will receive a retirement benefit of 20 percent of salary (1/2 percent x 40 years).
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