Defined Benefit Plan

A defined benefit plan is a type of retirement plan where the employer promises to pay a specific, predetermined benefit to an employee after they retire, usually as a monthly payment for life. This is the classic "pension" that older workers may remember: it pays out based on a formula, not on how well any investments happened to perform.

The formula typically factors in things like how many years the employee worked, their salary (often an average of their final or highest-earning years), and a set multiplier. Because the payout is fixed by this formula in advance, the employer is the one who has to figure out how much money to set aside and invest today to be able to cover that promised amount decades from now.

The key nuance is where the risk sits. In a defined benefit plan, the employer bears the investment risk: if the plan's investments underperform, the employer still owes the same promised benefit and has to make up the shortfall. This is the opposite of a defined contribution plan (like a 401(k)), where the employee contributes and invests their own money, and their eventual balance simply reflects however those investments performed, good or bad.

People sometimes confuse "defined benefit" with "defined contribution" because both involve retirement savings and employers. The distinction to hold onto is what's fixed: in a defined benefit plan, the output (the eventual benefit) is fixed by formula; in a defined contribution plan, the input (what goes into the account) is fixed, but the eventual output is not guaranteed.