A Defined Benefit Pension Plan is a type of retirement benefit plan that employers provide to their employees. The post-retirement payouts available under the plan are set on a well-defined formula in which the employee’s tenure, salary, and age are taken into consideration. This formula is highly based on the terminal earnings of the employee, i.e., their final salary and does not get affected by the returns generated by the pension fund.
Due to the presence of this defined formula, which makes the amount of benefits known to both the employers and employees, these plans are known as Defined Benefit Pension Plans. Let’s explore these plans in detail in this article!
Defined Benefits Plans Vs Defined Contribution Plans
Most of us often confuse Defined Benefits Plans and Defined Contribution Plans as the same thing. However, a Defined Contribution Plan is very different from a Defined Benefit Plan.
Unlike Defined Benefits Plans, the amount of benefits receivable under a Defined Contribution Plan is unknown. It depends on the amount of contribution provided by us as employees and our employers. The benefits also depend on the returns generated by the pension fund, which invests the received contributions in different asset classes such as equity and debt instruments.
Since a part of the contribution is made by us, we can choose whether we wish to invest in an aggressive fund or a conservative fund, or a hybrid one, depending upon our risk appetite and investment preferences. One of the most popular examples of Defined Contribution Plans is the National Pension System (NPS).
Defined Contribution Plans are ideal for those of us who like to decide the asset allocation of the fund ourselves based on our risk-taking abilities.
- A defined benefit plan is an employer-funded retirement plan that provides employees with defined post-retirement benefits.
- The amount of benefits under the defined benefits plan depends on the number of serviceable years of the employee in the company and their salary history.
- Defined Benefit Plans are different from Defined Contribution Plans.
Working of Defined Benefit Plans
A defined benefit plan gives post-retirement benefits to us based on three factors, namely tenure with the company, the amount of salaries drawn, and age. Each year the benefits to be paid through this plan are calculated using pension statistics, which in turn define the contribution that our employer needs to make towards these plans. Generally, employers are the sole contributors to defined benefit plans, however, sometimes, employees can also act as plan contributors.
In order to become eligible to receive these retirement benefits under the defined benefits plan schemes, we are required to work for a required number of years with the employer. We are not eligible for receiving these retirement benefits if we leave the job before completion of this vesting period fixed by the employer for availing of the defined benefits.
How Does a Defined Benefit Pension Plan Pays?
As an employee, we have the right to choose how we wish to receive the defined benefits. The payout options available under a defined benefits plan are explained below –
Under this option, we can choose to receive a fixed amount out of the total defined benefits on a monthly basis till we survive. It is important to note that no payouts are made to the spouse or other family members of the deceased pensioner under this option.
A Qualified Survivor and Joint Annuity
Under this option, the pensioner receives a fixed monthly amount o until their death. Also, after the death of the pensioner, the plan continues to pay a pension amount to their spouse till the time they live. However, there may be a variation in the amount of defined benefits paid to the spouse, which can be equal to at least 50% of the benefits received by the deceased pensioner.
A Lump Sum Payment
Under this option, the pensioner receives the entire value of their defined pension in the form of a lump-sum payment. And after the death of the pensioner, no further payments are made in their name.
Choosing the right payout option under a Defined Benefits Plan is necessary as it affects not only our financial stability but also our loved ones in times when we are not around them. So considering all the available options is highly important for making an informed and diligent decision.
Advantages of Defined Benefit Plans
A Defined Benefit Plan provide the following benefits to its members –
No Effect of Market Fluctuations
The market fluctuations do not affect the defined benefits available under the plan as the benefits do not depend on the returns generated by the pension fund.
A Defined Benefit Plan provides guaranteed benefits after retirement. This helps us stay worry-free about our everyday expenses post-retirement, as we will receive a regular income according to the selected payout option. It provides a sense of security for post-retirement days, along with peace of mind and financial independence.
Security for Spouse
Even after the death of the pensioner, their spouse can receive a post-retirement income under a Defined benefit pension plan if the pensioner chooses the same while selecting the payout options.
Improvement in Employee Retention
The data has reflected that many companies have witnessed improvement in retaining employees after the introduction of defined benefits as it gives them a sense of belongingness to a place which they feel cares for them and their loved ones.
Employee Pension Scheme – The Most Popular Defined Benefit
The Employee Pension Scheme (EPS) is the most popular defined benefit plan available in India. Let’s explore EPS in detail below –
- The Employee Pension Scheme (EPS) is one of the three employee benefits schemes offered by the Employees’ Provident Fund Organisation.
- All the individuals employed in the organised sector, who have been in service for at least 10 years are eligible for the scheme if they earn at least INR 15,000 monthly.
- The amount of retirement benefit under the Employee Pension Scheme is calculated on the basis of a formula which is equivalent to the product of our Pensionable Salary and the Pensionable Service divided by 70.
- Every employer is required to contribute 12% of the basic salary and dearness allowance of all eligible employees to the EPFO. Out of this, 8.33% goes towards the EPS and the remaining is invested in the Employee Provident Fund (EPF).
Did You Know?
The Employee Pension Scheme (EPS) has more than 60 Lakh members!
Words To Remember
- Vesting Period – It refers to the minimum number of years for which an individual must remain employed with an employer in order to be eligible for receiving the defined benefits.
Defined Benefits Plans are ideal post-retirement plans which provide us with not only guaranteed benefits but with a sense of financial independence during the golden years of our life. Also, the knowledge of the amount of benefits which is receivable helps us plan our finances in an informed and optimal manner. We can either use them to meet our day-to-day expenses or put them into any other investment instrument to further appreciate our wealth and enjoy life on our terms even when we are no longer employed.
Frequently Asked Questions (FAQs)
To be eligible to receive these retirement benefits under the defined benefits plan, we are required to work for a certain number of years known as the vesting period with the employer.
Under the Employee Pension Scheme (EPS), we are eligible to receive the defined pensions on retiring after the age of 58 years.
Yes, a pensioner can choose to provide the defined benefits after their death to their family members. For this, we need to carefully select the required payout option available under defined benefits plans.
The Employee Pension Scheme (EPS) is the most popular defined benefit plan in India with over 60 Lakh subscribers.
Yes, there is an option to receive the defined benefits by way of a single annuity plan that provides a fixed monthly pension amount till the time we live.