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A defined benefit plan is an employer-funded program that pays benefits to employees based on factors like salary history and years of employment. The benefits are shared either in fixed monthly payments like an annuity or in one-time lump sum payments.
Retirement is an age that everyone wishes to enjoy peacefully and hassle-free. And the best way to ensure you retire comfortably is by creating a proper retirement plan while working. The earlier you plan for retirement, the better the chances to accumulate the required corpus.
One way to achieve this corpus is by a defined benefit plan.
As the name suggests, this retirement plan gives a defined pension amount post-retirement. In the article below, we have discussed defined benefit pension plans, how they work, their advantages and types.
What are Defined Benefit Retirement Plans?
A defined benefit pension scheme offers definite retirement benefits for employees. The employers largely fund these plans, and the retirement payouts are typically determined by a set formula, which may include the employee's salary, years of service at the company and age.
Consistency and discipline in investment form the core of a defined benefit pension plan. Gratuity, leave salary, and employee life insurance are India's most popular types of defined pension schemes.
Features of defined benefit retirement plans:
- The benefits of these plans are based on length of service and salary
- A defined benefit pension is different from a defined contribution pension plan, as in the former, the employer is the only contributor to the plan. In contrast, in the latter, the employer and the employee contribute to the plan.
- The benefit is payable in the form of one lump-sum payment or a fixed monthly payment like an annuity.
- After the employee's death, the surviving spouse is eligible to receive this benefit.
- Employers should resort to group insurance policies to offer these benefits and avoid liquidity issues.
How Does a Defined Benefit Plan Work?
A defined benefit pension plan ensures that the employee or the policyholder receives certain benefits at retirement. The benefit amount depends on various factors like the salary, age and number of years of service at a company. Traditionally, the employer offered these benefits to the employee for retention purposes.
This type of plan is generally employer-sponsored, and only in rare cases may the employee need to contribute. However, or avail of this type of retirement benefit, you must have worked for an organisation for a certain number of years. This period is referred to as the vesting period.
But, if you quit the job before the completion of this vesting period, you may not receive full retirement benefits from that plan.
Advantages and Disadvantages of Defined Benefit Pension Plan
Advantages |
Disadvantages |
Higher retirement benefit |
Unable to make an investment decision |
Benefits are unaffected by market fluctuations |
The vesting period can be long |
After the employee’s death, the spouse can receive the benefit |
High maintenance cost for the employer as they have to provide assured payouts regardless of market conditions |
Employers get tax* benefits |
|
Helps improve employee retention |
|
Types of Defined Benefit Plans in India
In India, Landscape offers both defined benefit and defined contribution pension plans. The following are some of the types of defined benefit plans.
- Gratuity Payment: Statutory benefit paid by the employer to its employee for rendering 5 or more years of continuous service.
- Leave Salary: This benefit helps promote work-life balance among employees, and the balance of leaves can be encashed.
- Employee Life Insurance: This employer-funded benefit is available to the employee's family in case of the unfortunate death of the employee during the service.
- Employee Personal Accident Insurance: This insurance covers for employee's medical treatment, accidental death, or disability. The employer pays the premiums.
- Workers Compensation: It is a statutory benefit paid by the employer to the employees or workers and their dependents in case of workplace-related injury.
- Atal Pension Yojana: This government-backed defined benefit pension scheme targeting the unorganised sector.
- Guaranteed1 Pension Plans: This type of defined benefit pension plan is offered by the life insurance company, wherein typically, with a one-time investment, you get a regular flow of income post-retirement. These plans may require contribution by the employee as well.
Wrapping Up
A defined benefit plan is one of the ways to help employees reach the desired corpus, and it can be a crucial component of retirement planning. Understanding these plans in detail will help you maximise your profit.
Apart from employer-provided plans, you can also look for retirement plans in India with life cover from an insurance company. Such plans offer dual benefits of life insurance coverage with retirement savings.
