Calculating Defined Benefit Plan Benefits
Contributions to a defined benefit plan are based on what is needed to provide definitely determinable benefits to plan participants. Actuarial assumptions and computations are required to figure these contributions.
Defined benefit plans typically are funded entirely by the employer. Employers generally contribute enough annually to cover the normal cost of the plan—an amount that is at least the value of the benefits that participants in the plan earned that year. In addition, employers may have to make additional contributions for various reasons, such as to make up for any investment losses by the pension fund. If an employer fails to make the legally required contributions, the employer can be assessed penalty taxes for each year the deficiency exists. If an employer is experiencing temporary financial hardships, the IRS may permit the employer to pay the contribution in future years under a funding waiver arrangement
A defined benefit pension plans use a formula to figure the benefit amount earned. Usually, it involves salary and years of service (for example, a certain percentage of the employee’s final or average salary multiplied by the number of years of service) or a flat benefit amount per year of service. The actual dollar amount will depend on such factors as: age at retirement; earnings (in plans that use salary to compute benefits); and years of service under the plan.
In general, the longer someone works under the same defined benefit pension plan, the larger the retirement benefit. Employees can start receiving pension benefits when they reach the normal retirement age set by their pension plan. The normal retirement age generally is no later than age. Workers should check their pension plans for the normal retirement age and become familiar with the other provisions of their plans. Many pension plans allow workers to take early retirement upon completing a certain number of years of service and/or reaching a given age. But if workers decide to retire early, they may receive a lower monthly benefit than they would at normal retirement age, because the benefit will be paid over a longer period of time.