Defined Benefit Plan

Defined benefit (DB) plans — commonly known as pensions — were the dominant form of employer-provided retirement savings in America through the 1970s. Under a DB plan, the employer promises a specific retirement income, and takes on the full responsibility of funding and investing the plan assets to meet that promise. This is the mirror image of a defined contribution (DC) plan such as a 401(k), where the employee bears both the investment risk and the longevity risk, with no guaranteed income amount.

In the private sector, DB plan coverage has declined sharply over the past four decades. The number of private-sector DB plan participants peaked around 1980 and has fallen dramatically as employers shifted to less costly and more predictable DC plans. Today, defined benefit pensions remain much more common in the public sector — state and local government employees, federal employees, military personnel, and teachers frequently participate in DB plans. Approximately 15% of private-sector workers still have access to a traditional DB pension, mostly at large corporations, utilities, and unionized employers.

A pension's value is determined by its formula. The most common formula is the flat benefit or career average formula, but the most widely recognized is the final average pay formula: multiply years of service by an accrual rate (typically 1.0 to 2.5%) and then multiply by the average salary over the final three to five years of employment. An employee who works 30 years for a public school district with a 2% accrual factor and a final average salary of $80,000 would receive a pension of 30 × 2% × $80,000 = $48,000 per year for life. Most DB plans also include survivor benefits, early retirement options, and cost-of-living adjustment provisions that modify the base formula.

Defined benefit plans are funded by the employer making contributions to a trust that invests the assets. When investment returns fall short of actuarial assumptions, the employer must make additional contributions — the 'underfunding' problem that has plagued many state and municipal pensions. Private-sector DB plans must comply with ERISA and the Pension Protection Act of 2006, which set minimum funding requirements, benefit accrual rules, and participant rights.

Pension Calculation Methods: Employers use several distinct formulas to determine the monthly retirement benefit earned under a defined benefit plan. The final average pay formula — the most common in the public sector — calculates benefits based on the product of years of service, an accrual rate, and the average salary over the employee's highest-earning three or five consecutive years. A public safety employee with 25 years of service, an accrual rate of 3%, and a highest-five-year average salary of $90,000 would earn a pension of 25 × 3% × $90,000 = $67,500 per year. The career average formula bases benefits on average salary over the entire career rather than final years, producing a smaller benefit for workers with strong late-career earnings growth. The flat benefit formula, common in collectively bargained plans, pays a fixed dollar amount per year of service — for example, $75 per month per year of service, so 30 years produces $2,250 per month ($27,000 per year) regardless of salary. Cash balance plans are a hybrid variant: the employer credits a hypothetical account with pay credits (typically a percentage of salary) and interest credits each year, and the accumulated hypothetical balance determines the benefit. Cash balance plans look like DC plans to the employee but are legally defined benefit plans, with the employer bearing investment risk on the underlying assets.

PBGC Protection: The Pension Benefit Guaranty Corporation (PBGC) is a federal agency established by ERISA in 1974 that insures benefits under private-sector single-employer and multiemployer defined benefit plans. If a sponsor of a single-employer plan becomes insolvent and the plan is underfunded, the PBGC takes over the plan and continues to pay benefits — up to statutory maximums. For 2025, the PBGC maximum monthly guarantee for a single-employer plan participant who retires at age 65 is approximately $7,107 per month ($85,284 per year). Benefits above this cap are unprotected: a highly paid executive with a pension promising $200,000 per year would receive only the PBGC guarantee if the employer terminates the plan in distress. The PBGC guarantee is funded by premiums paid by pension sponsors and by the assets of plans it takes over; it does not receive direct appropriations from Congress. Multiemployer plans — common in industries like trucking, construction, and retail, where multiple employers contribute to a single union-sponsored pension — operate under a separate, less generous PBGC insurance program with lower guarantee levels. Several multiemployer plans became severely underfunded after the 2008 financial crisis and again during the COVID-19 pandemic; the American Rescue Plan Act of 2021 provided $86 billion in federal relief to the most troubled multiemployer plans through a special financial assistance program administered by the PBGC.