Defined Benefit Plans

Now that you understand the qualified vs. non-qualified framework, let's look at the first major type of qualified plan. A defined benefit plan is the traditional pension; it promises a specific dollar amount at retirement.

Structure and Characteristics

• Promises a specific retirement benefit based on a formula (typically salary history and years of service)
• The employer bears the investment risk; if plan investments underperform, the employer must increase contributions to fund the promised benefit
• Contributions are determined by actuarial calculations, not a fixed dollar amount
• The employee's benefit is fixed regardless of market performance
• Employees do not direct investments; the plan's trustees manage the portfolio

Key Features

• Maximum annual benefit (2026): $285,000 or 100% of average compensation for the highest 3 consecutive years, whichever is less (Internal Revenue Code (IRC) Section 415(b))
• Employer contributions are mandatory and must be actuarially sufficient
• Vesting schedule applies to employer contributions
• Employees are always 100% vested in their own contributions
• Benefits are insured (up to limits) by the Pension Benefit Guaranty Corporation (PBGC)

Exam Tip: Gotchas

• "Actuarially determined" means there is no fixed contribution amount. The employer contributes whatever is needed to fund the promised benefit; this amount changes year to year.
• Employees in a defined benefit plan do not choose their investments. Plan trustees manage the portfolio, not individual participants.

PBGC Insurance

The Pension Benefit Guaranty Corporation is a federal agency that protects participants in private-sector defined benefit plans:

• If a plan is terminated without enough assets to pay benefits, the PBGC steps in
• Covers single-employer and multiemployer plans
• Funded by insurance premiums paid by sponsors of defined benefit plans
• Does not cover defined contribution plans (401(k), 403(b), etc.)
• Does not cover government or church plans

Exam Tip: Gotchas

• The PBGC only insures defined benefit plans, not defined contribution plans. Do not confuse the two; 401(k) and 403(b) plans have no PBGC backstop.
• In a defined benefit plan, the employer bears all investment risk. If the plan's investments underperform, the employer must increase contributions. The employee's benefit is fixed. This is the opposite of a defined contribution plan, where the employee bears the risk.

Defined Benefit vs. Defined Contribution: Quick Preview