2025 Defined-Benefit Plans Explained: Costs, Examples & Payment Methods

Julia Kagan is a financial and consumer journalist and former senior editor of personal finance at ZAMONA.

A defined-benefit plan is a retirement program sponsored by employers where the retirement benefits are predetermined through a formula that takes into account factors like an employee’s length of service and salary history. Typically, participation requires employees to complete a minimum period of employment, with some plans imposing waiting periods after breaks in service.

Employers manage the investments and assume the associated risks, often hiring external managers to oversee the funds. Unlike 401(k) plans, employees generally cannot withdraw funds at will; instead, they receive fixed monthly payments similar to annuities or sometimes a lump sum based on the plan’s guidelines.

Key Insights

• Defined-benefit plans, commonly known as pensions, guarantee specific retirement benefits.
• The employer bears all investment and planning risks, unlike defined-contribution plans.
• Benefits are paid as fixed monthly annuities or lump sums.
• Surviving spouses often continue to receive benefits after the employee’s death.

Understanding Defined-Benefit Plans

Also called pension or qualified-benefit plans, these arrangements define retirement benefits upfront through a formula, unlike savings accounts where payouts depend on investment performance.

Employers handle investment decisions and bear financial risks. Poor returns or miscalculations can lead to funding shortfalls, legally obligating employers to contribute additional funds.

Examples of Defined-Benefit Payouts

Defined-benefit plans promise a specific retirement benefit, calculated based on years of service, age, and average salary. Employers typically fund these plans by contributing a set percentage of the employee’s salary into a tax-deferred account. Employees may also contribute depending on the plan.

Upon retirement, payments may be made monthly for life or as a lump sum. For example, a retiree with 30 years of service might receive $150 per month for each year worked, totaling $4,500 monthly. Some plans also provide surviving beneficiaries with remaining benefits.

Important Considerations

Choosing the right payment option significantly affects benefit amounts, so consulting a financial advisor is recommended.

Defined-Benefit Plans vs. 401(k)s

Unlike 401(k) plans, which depend on employee contributions and investment returns, defined-benefit plans guarantee a fixed retirement income.

Payment Options for Defined-Benefit Plans

Common options include single-life annuities providing fixed monthly payments until death, qualified joint and survivor annuities allowing benefits to continue for surviving spouses, or lump-sum payments distributing the full plan value at once.

Disadvantages of Defined-Benefit Plans

Since payouts are formula-based, employees might not benefit from strong market performance as much as those with defined-contribution plans like 401(k)s.

The Bottom Line

Understanding how defined-benefit plans work enables smarter retirement planning. Working additional years can increase benefits by raising years of service and final salary used in calculations. Some plans also boost benefits if employees work past the normal retirement age.

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