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Designing and Administering Defined Benefit Retirement Plans


Defined benefit plans, also known as pension plans, are retirement plan programs sponsored by employers. They are contrasted with the other common type of retirement plan program, which is the defined contribution plan. Defined benefit plans, as the name implies, provides participants with a definitely determinable benefit payable over a fixed period of time. See Types of Retirement Plans.

According to SHRM's 2019 Employee Benefits Report, pension plans continued to decline in popularity over the last five years with only 21 percent of employers offering a traditional defined benefit pension plan that was open to all employees. Ten percent had a frozen defined benefit plan, and 93 percent of surveyed employers had a traditional 401(k) or similar defined contribution retirement savings plan.

Employer-sponsored retirement benefits are an increasingly significant part of both employees' total compensation and their considerations when deciding to accept a new job. This is even truer in the current environment given the uncertainty surrounding the future of Social Security as a source of retirement income. However, contributing to a retirement benefit program, and paying the related administrative costs, can command a substantial portion of an employer's total compensation budget. As a result, employers have a vested interest in designing and maintaining a retirement benefit program that balances recruiting and retention benefits it generates with the costs incurred by, and financial liability imposed on, the employer.

An additional, and growing, purpose for providing employer-sponsored retirement programs is to both enable and encourage older workers to leave the workforce. Employers are discovering that employees who do not have sufficient retirement savings remain in the workplace out of necessity, which impedes the employer's efforts to hire new workers or promote existing employees. By helping older workers feel financially secure enough to retire, employers can create job vacancies that can be filled with workers with new and different skill sets, as well as lower overall total compensation costs.

See Help Employees Turn Retirement Savings into Lifetime Income.


If you establish a defined benefit plan, you:

  • Can have other retirement plans.
  • Can be a business of any size.
  • Need to annually file a Form 5500 with a Schedule B.
  • Have an enrolled actuary determine the funding levels and sign the Schedule B.
  • Can't retroactively decrease benefits.
Source: IRS Choosing a Retirement Plan: Defined Benefit Plan.

Legal Issues

The design and operation of tax-qualified retirement plans, including defined contribution plans, are strictly and extensively regulated by two federal laws—the Internal Revenue Code (primarily, Part I of Subchapter D of Chapter 1) and the Employee Retirement Income Security Act of 1974 (ERISA). In addition, there are a multitude of related regulations and government agency pronouncements that may apply. Many of the applicable sections of the Internal Revenue Code and ERISA are identical. Under the Reorganization Plan No. 4 of 1978, enforcement responsibility for these duplicated legal requirements was assigned to the U.S. Department of the Treasury, as implemented by the Internal Revenue Service (IRS). The Employee Benefits Security Administration (EBSA) of the U.S. Department of Labor is responsible for enforcing the reporting and disclosure requirements in ERISA that are not duplicated in the IRS Code, in addition to the statutory duties imposed on plan fiduciaries under ERISA.

Both the IRS and the EBSA are active in enforcing their respective obligations. The EBSA focuses more on a plan's relationship with its participants, including required disclosures to participants and participants' claims for plan benefits, as well as the management of a plan and its assets by the plan's fiduciaries. The IRS focuses primarily on the plan's compliance with the applicable nondiscrimination requirements as well as ensuring that the plan document both includes all mandated statutory and regulatory provisions and is administered in compliance with those provisions.

In general, complying with the legal requirements enforced by the IRS is necessary to secure and preserve the tax-favored treatment of benefits provided under a qualified defined contribution plan. In contrast, complying with the legal requirements enforced by the EBSA is necessary to avoid the imposition of penalties on the plan administrator and the individuals with the authority and responsibility for operating the plan.

See Meeting Your Fiduciary Responsibilities (Under subtopic Publications).

Plan Design

Benefit formula

Every defined benefit plan is designed with a formula that sets out the benefit to be paid starting as of a set time. The time or date is usually normal retirement age as defined below or a normal retirement date, which is a date on or after attaining normal retirement age.

The formula can be as simple as a set dollar amount per month (e.g., $500 per month for life starting as of normal retirement age). The formula can be more complex, such as a dollar amount per month, multiplied by the years of service the participant works for the employer. This type of formula is often found in collectively bargained plans (e.g., $5 x years of service). In such a plan, a participant with 25 years of service would be entitled to a benefit of $125 per month.

Other typical formulas involve compensation and service credits. Two popular formulas are final average pay formulas and career average pay formulas:

  • A final average pay formula creates a benefit based on the compensation paid to the participant over the last years of employment. The number of final years can vary, but three to five years are typical. The participant then receives a fixed percentage of that amount, typically determined by reference to the participant's years of service.
  • A career average pay formula provides a benefit similar to that provided under the final average pay formula, but the average is often created using compensation for the entire period of time the participant is covered by the plan.


ERISA and the IRS Code require defined benefit plans to vest participants after a period of service or the occurrence of certain events. All plans are required to vest participants when they attain normal retirement age. See Firing of FBI's McCabe Spotlights Benefits-Vesting Issues.

There are two plan design options for vesting:

Cliff vesting – employees become fully vested in the defined benefit plan after a certain number of years. Under ERISA, private-employer plans are subject to a five-year maximum for cliff vesting.

Years of Service Vesting Percentage
0 0

Graduated vesting – employees become partially vested based on years of service. ERISA requires the following minimum vesting schedule:

Years of Service Vesting Percentage

 A plan that is top-heavy, or a cash balance plan (described below), must vest under schedules at least as fast as either of the following vesting schedules:

Three-year cliff schedule

Years of Service Vesting Percentage

 Two- to six-year graduated schedule

Years of Service Vesting Percentage

See §1053. Minimum vesting standards


Generally, a plan must preserve the service credit an employee accumulated if the employee is rehired within five years.

Benefit payments

Defined benefit plans are set up to pay the defined benefit for a fixed period, typically for life, although employee confidence in the actual future payment of those benefits continues to diminish. There are a variety of forms such payments can take.

Single Life Annuity

The typical form (or "normal" form) of benefit payment is a fixed amount determined under the formula of the plan for as long as the participant is alive. Payments are typically made monthly.

The IRS Code and ERISA require that if the participant is married, the normal form of payment must be at least a joint and 50 percent survivor annuity, which is the actuarial equivalent of the single life annuity payment.

Joint and Survivor Annuity

An alternative form of payment is a fixed amount that is paid over the life of two people. In addition to the required form, other typical forms of joint and survivor annuities include joint and 100 percent survivor or joint and 66-2/3 percent survivor.

What this means is that the amount is calculated as payable to the participant. This amount is less than what would be payable to the participant as a single life. Upon the participant's death, the same amount, in the case of a joint and 100 percent survivor annuity, continues to be paid to the beneficiary until the beneficiary's death. If a lesser percentage survivor annuity is chosen, then a reduced amount is payable to the beneficiary for life. For example, if the participant's benefit is $3,000 per month, the survivor would receive the following amounts for life after the participant's death:

Joint and 100 percent survivor$3,000
Joint and 75 percent survivor
Joint and 50 percent survivor$1,500
Joint and 33-1/3 percent survivor

Period Certain and Life Annuity

A different type of annuity is a period certain and life annuity, which provides a payment that is the actuarial equivalent of the normal benefit. It is payable for the life of the participant but guarantees a minimum number of years of payments. A 10-year certain and life annuity would pay a benefit to the participant for his or her life. However, if he or she dies before 10 years of payments have been paid, the payments would continue to the designated beneficiary until 10 years of payments had been made. For example, if the participant dies after eight years of payment, the last two years would be paid to a beneficiary. If the participant dies after 12 years of payments, payments would stop with the participant's death.

Lump-Sum Payment

A defined benefit plan may permit participants to receive a lump-sum payment of their benefit rather than receiving a stream of payments over time. To minimize the administrative burden of dealing with tracking relatively small benefits, most plans require that small benefit amounts be paid out in a lump sum. The threshold of small benefits is typically when the actuarial equivalent value of the benefit is $5,000 or less. Larger plans frequently do not permit larger lump-sum payments, because they can create cash drains on the plan and are counter to the philosophical intent of providing a retirement income to the participants. 

Participant and Spousal Consent

ERISA and the IRS Code require that any payment of benefits in excess of $5,000 cannot be made without the participant's consent, other than the required minimum distributions after the participant reaches age 72 and other limited exceptions. In addition, ERISA and the IRS Code mandate that any election of a participant to designate a beneficiary other than the spouse, or to elect a form of benefit other than the required form, must have the consent of the spouse. That consent must be witnessed by a plan representative or a notary public.

Normal retirement age

Defined benefit plans are designed so that benefit accruals, benefit payment and funding are all related to the attainment of normal retirement age (NRA). Every defined benefit plan must define the NRA. Typically, ERISA and the IRS Code provide that the NRA may not be greater than age 65, with the following exception: ERISA and the IRS Code permit a plan to define normal retirement age to be the latter of age 65 or five years of participation. The advantage to this is that an employee who is hired at age 61 or older would need to be in the plan for five years before attaining the NRA. This gives the plan more time to fund the benefit.

Defined benefit plans are precluded from paying participants while they are still working. The exception is that a plan may start benefit payments to a participant while the participant is still employed after he or she attains the NRA. To avoid real or perceived abuses, the IRS mandates that the NRA may not be lower than age 62 unless the employer can demonstrate that a lower age is standard in its industry.

Phased Retirement

To permit employers to retain talented older employees who may wish to work less than full time, plans may permit 62- to 64-year-old employees to take benefits while still employed, or the NRA can remain at 65. This is what has been called "phased retirement." See Many Older Workers Would Prefer to Ease into Retirement.

Payment on Termination Before Normal Retirement Age

As mentioned above, defined benefit plans are designed to fund and distribute benefits after a participant reaches the NRA. Because of this, it is not uncommon for defined benefit plans to withhold benefits until the terminated participant reaches the NRA. This could mean a 50-year-old vested participant who terminates employment will not receive a benefit payment for up to 15 years, assuming an NRA of 65. The payment of small lump-sum benefits of $5,000 or less are frequently an exception to that rule.

Early Retirement Age

As a means of ameliorating the delay in payments, many defined benefit plans use the concept of an early retirement age. This is an age younger than the NRA, and it is often coupled with a service requirement. For example, a plan may provide for an NRA of 65 with an early retirement age of 55 with 10 years of service. This would mean that a participant between ages 55 and 64 who has earned at least 10 years of service in the plan could terminate employment and begin to receive immediate payments. The payments would typically be actuarially adjusted to pay fewer benefits because the plan is now paying a benefit to the participant for a longer period of time. The amount of the reduction is determined under the terms of the plan. The reduction is less the closer the participant is to the NRA.

When Age Matters

​An employer-sponsored retirement plan cannot exclude an employee from participating after the employee turns age 21 (and completes the necessary service requirement).

Note: SIMPLE IRA plans have no minimum age requirement.


​In the year of turning 50 or older, annual catch-up contributions may be made to:
  • IRAs
  • employer-sponsored plans that accept elective deferrals
A public safety employee who receives a distribution from a governmental defined benefit plan after separation from service is not subject to the 10% additional tax on early distributions if the distribution occurs in the year of turning 50 or older.
​An employee who receives a distribution from a qualified plan after separation from service is not subject to the 10% additional tax on early distributions if the distribution occurs in the year of turning 55 or older.
​Distributions from qualified retirement plans, including IRAs, are not subject to the 10% additional tax on early distributions once the recipient turns 59½.
​A pension plan may pay benefits to a participant age 62 or older even if the participant has not separated from employment. The rules regarding a plan’s youngest permissible normal retirement age have a safe harbor of age 62.

​Defined benefit plans often calculate retirement benefits based on annuities beginning at age 65. 

Unless a participant elects otherwise, benefits under a qualified plan must begin within 60 days after the close of the latest plan year in which the participant:

  1. turns 65 (or the plan’s normal retirement age, if earlier);
  2. completes 10 years of plan participation;
  3. or terminates service with the employer.


Required minimum distributions must generally start by April 1 following the year of turning 70½, for plan participants and IRA owners who reach age 70 ½ prior to January 1, 2020. 

A qualified plan may allow participants to delay taking distributions until after retirement (unless the participant is a 5% owner).

​The SECURE Act made major changes to the RMD rules. For plan participants and IRA owners who reach the age of 70 ½ in 2019, the prior rule applies and the first RMD must start by April 1, 2020.  For plan participants and IRA owners who reach age 70 ½ in 2020, the first RMD must start by April 1 of the year after the plan participant or IRA owner reaches 72.
Source: IRS.


A 2015 final rule, Annual Funding Notice for Defined Benefit Plans, requires administrators of defined benefit plans subject to ERISA to furnish a funding notice every year to each plan participant and beneficiary as well as to the Pension Benefit Guaranty Corp. (PBGC), labor unions representing participants or beneficiaries, and in the case of a multiemployer plan, each employer that has an obligation to contribute to the plan.

An employer sponsoring a defined benefit plan is required to make sufficient contributions to the plan to keep it in a position to pay benefits when due. As such, ERISA and the IRS Code require the use of an actuary to calculate the minimum amount needed every year. If the employer fails to make the minimum contribution, it faces excise taxes. Contributions normally must be made quarterly.

Under stricter standards added by the Pension Protection Act of 2006, actuaries are required to notify plan sponsors if the funding level of the plan falls below a certain threshold. There is a sliding scale of restrictions on what a plan may do as the funding level declines. These restrictions include limiting how much a plan can pay out as benefits and limiting plan amendments that increase benefits or change the rate of vesting.

Cash Balance Plans

A cash balance plan is a specific type of defined benefit plan that has gained popularity in recent years. Like defined benefit plans, generally the benefit is defined. But rather than being defined in a fixed amount determined under a formula, the benefit from a cash balance plan is determined by reference to a hypothetical account.

Each participant has a hypothetical account. No assets are segregated or separately invested for the participant. Instead, the account is for record-keeping purposes only.

Each year the hypothetical account has amounts credited to it. This amount is frequently a percentage of the participant's compensation (e.g., 5 percent of pay). Sometimes it could simply be a fixed dollar amount (e.g., $1,000).

In addition, each year the account is also increased by an interest rate specified in the plan. This interest rate is credited, typically annually, although some plans may credit interest monthly. The rate is unrelated to the actual earnings or losses of the plan's investments. The rate generally used is the 30-year Treasury rate.

The hypothetical account continues to increase in value until the participant is entitled to payment. At that point, the hypothetical account is recalculated based on the actuarial assumptions specified in the plan into an annuity form of benefit. If the plan permits a participant to elect a lump-sum benefit, with appropriate spousal consent, the lump-sum payable should equal the amount of the participant's hypothetical account balance.

The Pension Protection Act drafted specific rules on how cash balance plans may be designed. The IRS Code refers to these plans as statutory hybrid plans, meaning they are a hybrid of defined benefit and defined contribution plans.

See IRS Fact Sheet: Cash Balance Pension Plans.

Converting to a cash balance plan

It is possible to convert a traditional defined benefit plan into a cash balance plan. Very simplistically, this would typically be done by freezing accruals under the traditional defined benefit plan and then converting the current accrued benefit into a lump-sum value. This converted lump-sum amount becomes the opening amount in the hypothetical account. Further accruals would then follow the cash balance plan concept of crediting the hypothetical account with accruals and interest.

Before the Pension Protection Act's codification of cash balance plans as statutory hybrids, there were a number of lawsuits regarding conversions. Depending on the traditional defined benefit designs before the conversion, there is typically a dramatic increase in benefit accrual and value the closer a participant reaches the NRA. Freezing and fixing that benefit and then accruing both older and younger participants at the same rates looked like age discrimination.

Under the Pension Protection Act, conversions of traditional defined benefit plans to cash balance plans are permitted without the risk of a claim of age discrimination provided the rules for conversion under the act are followed.


ERISA mandates certain communications with defined contribution plan participants, including summary plan descriptions and annual reports on the plan's financial activity. See Reporting and Disclosure Guide for Employee Benefit Plans (Under Publications).

Additional disclosures to plan participants are required under the IRS Code under certain circumstances, such as when the plan satisfies a safe harbor requirement to avoid nondiscrimination testing of employer contributions, or if the plan automatically enrolls newly eligible participants to make employee contributions to the plan.

Communicating with plan participants about the terms of the plan is an activity subject to the fiduciary responsibility requirements under ERISA. HR professionals charged with drafting communications to plan participants or dealing directly with plan participants on plan issues need to take care to make sure those communications are accurate, complete, objective and carefully drafted or phrased to be understandable by the average plan participant.

Role of the Pension Benefit Guaranty Corporation

The Pension Benefit Guaranty Corporation (PBGC) is a government agency charged with insuring the benefits payable under defined benefit plans. Defined benefit plans that are sponsored by professional employers, such as physician groups covering 25 or fewer participants, or self-employed persons covering only themselves and their spouses, are not covered by the PBGC. Certain Puerto Rico plans and certain church plans are also excluded.

The PBGC charges an annual premium per participant for this insurance. The amount of the premium varies depending on the funded status of the plan. The base premium increases as funding levels decline. 

If a defined benefit plan covered by the PBGC terminates or finds itself in a serious financial situation, the PBGC will take over the plan and pay benefits. However, the PBGC does not cover all benefits, only a certain amount. 

See PBGC Raises Pension Premium Rates for 2020.

Freezing a Plan

Because the process to terminate a defined benefit plan is complex and often costly, some employers choose to freeze their plan as an alternative. Some common options for freezing a plan include:

  • Closing the plan to new participants.
  • Halting benefit accruals for current participants while still allowing benefit increase based on wage increases.
  • Halting benefit accruals for only certain participants.
  • Halting all accruals and benefit earnings for all participants.

See GE Freezes Pension Plan for 20,000 Employees and IRS Extends Nondiscrimination Relief for Frozen Pensions to 2021.

Plan Termination

Employers may terminate defined benefit plans. The process, however, is very involved. If the plan is sponsored because it was bargained for with the union covering the participants, then the employer must negotiate the termination. Once the decision to terminate is made, the appropriate corporate or employer action must be made to terminate.

Steps to Terminate a Plan:

  • Amend the plan to:
    • Establish a plan termination date.
    • Update the plan for all changes in the law or plan qualification requirements effective on the plan’s termination date.
    • Cease plan contributions.
    • Provide full vesting of benefits to all affected employees on the termination date.
    • Authorize the plan to distribute all benefits in accordance with plan terms as soon as administratively feasible after the termination date.
  • Notify all plan participants and beneficiaries about the plan termination.
  • Provide a rollover notice to participants and beneficiaries.
  • Plan to pay any outstanding required employer contributions to the plan.
  • Vest all “affected participants” 100%.
  • Distribute all plan assets as soon as administratively feasible (generally within 12 months) after the plan termination date to participants and beneficiaries.
  • File any applicable final Form 5500 series return.

Source: IRS.

If the plan is covered by the PBGC, the PBGC must also be notified in forms filed together with information regarding the benefits that are due, and the assets available to pay them. If the assets held in the plan are sufficient to pay all benefits, or the employer commits to contributing enough to fully fund all benefits, the plan can terminate in what the PBGC calls a "standard termination." The PBGC will review all the information and confirm that it has no liability for the plan. The termination process can then continue. The plan must vest all participants and satisfy its liability entirely, either by paying the benefits covered in a lump-sum payment or by purchasing annuities to provide the payment of the benefits.

If the assets are not sufficient to fund all benefits, the plan cannot terminate unless the PBGC takes it over. The PBGC will only take over if the employer requests a distress termination.

See Plan Terminations and Retirement Plan FAQs regarding Partial Plan Termination.


If the assets in the defined benefit plan are in excess of what is needed to pay the plan's liabilities, the surplus may return or revert to the employer. The amount of the reversion is taxable to the employer as ordinary income. It is also subject to a 50 percent excise tax. The excise tax can be lowered, but not eliminated, by establishing a qualified replacement plan covering at least 95 percent of the active participants of the terminated plan and transferring at least 25 percent of the maximum reversion amount to that plan to fund benefits. The qualified replacement plan can be a defined contribution plan.

Because of the confiscatory nature of the taxation of reversions, most employers try to structure plan terminations to avoid reversion. Some will amend the plans to increase benefits, thereby increasing the plan's liabilities. In addition to or instead of increasing benefits, employers will have the defined benefit plans pay as much as possible of the legitimate expenses of the plan related to ongoing operation, thereby reducing assets and eliminating the reversion.