Defined-Benefit Plans

Once employers decide to establish a defined-benefit plan, they face several choices:

First, the tax code requires that sponsors of such plans specify a formula that determines each participant's benefit on retiring. Formulas are generally based on length of service, a combination of earnings and length of service, or a percentage of contributions. Alternatively, defined-benefit plans may take the form of cash balance plans.

Second, employers can exercise discretion over specific elements within the formula, including:

Whether and how to integrate the plans with Social Security benefits;

The ages at which to allow normal and early retirement; and

Whether to provide postretirement increases in benefits in response to inflation.

Third, employers must establish parameters of the plan that are not directly related to the benefit formula. For example, they must decide:

• Whether to allow or require contributions by employees;
  
  
• What distribution options to offer employees on retiring;
  
  
• Whether to offer death benefits and a disability retirement option; and
  
  
• What types of portability provisions to adopt.

Unlike defined-contribution plans, defined-benefit plans need not address the issues of whether to give employees partial control over their investments or whether to allow loans or hardship withdrawals. Those features are prohibited by federal statute.