A defined benefit fund promises a retirement benefit calculated by a formula, typically based on years of service and final or average salary. The benefit is defined up front; the contributions needed to fund it are what vary.
What it means
In a defined benefit arrangement the employer carries the investment and funding risk: if returns fall short, the employer must make up the difference to deliver the promised benefit. These funds were once common but are now less so, because the open-ended liability is harder for employers to manage than a fixed contribution.
Where it fits in
For payroll, the contribution to a defined benefit fund is still calculated and deducted each period, but the rate reflects what the actuary determines is needed to fund the promised benefits rather than a simple percentage. The benefit fund setup records that it is a defined benefit structure.
Key rules
- The benefit is set by a formula of salary and service.
- The employer carries the investment and funding risk.
- Less common now than defined contribution funds.
- Contribution rates are actuarially determined to fund the promise.
