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Decades ago, defined benefit plans were the default retirement model in the United States, offering something rare: predictable income for life. But over time, they largely disappeared from the private sector, replaced by 401(k)s and other contribution-based plans.
Now, they’re making a comeback, especially in leadership compensation planning. For HR and legal teams managing pay across borders, defined benefit plans offer something contribution-based plans can’t: financial certainty in retirement. They simplify planning, build trust, and help companies retain top talent for the long haul.
In this guide, we’ll explore what defined benefit plans are, how different types work, and where they fit in a modern total rewards strategy.
What is a defined benefit plan?
A defined benefit retirement plan is an employer-sponsored pension plan that guarantees employees a specific monthly income after they retire. That payout, also called an annuity, is calculated using a formula based on salary history, total years of service, and retirement age.
Unlike defined contribution plans like 401(k)s, defined benefit plans put the investment risk on the employer. That means the company, not the employee, is responsible for funding the plan and managing the investments to make sure workers receive the full amount that the company promised them.
What’s the difference between defined benefit and defined contribution?
Both plan types help employees save for retirement, but they work very differently.
A defined contribution plan—such as a 401(k) or profit-sharing plan—focuses on contributions and investment options with no guaranteed payout. The account balance depends on market performance and how much the employee and employer contribute over time.
In contrast, a defined benefit pension guarantees a specific monthly payment, typically calculated using a formula based on earnings, years of service, and retirement age. This predictability simplifies retirement planning and shifts responsibility from employee to employer.
How does a defined benefit plan work?
From an employee’s perspective, a defined benefit plan is straightforward: Contribute your time and service to the company, retire, and receive a consistent monthly payment. But making that happen behind the scenes takes structure, forecasting, and long-term financial planning. Here’s how different types of defined benefit plans work:
Funding
The employer contributes to a dedicated trust, typically monthly or quarterly, based on projected liabilities. These contributions are calculated using actuarial models that factor in expected retirement age, salary progression, tenure, and life expectancy. Contributions are often tax-deferred, which brings tax advantages for both the employer and employee.
Investment
The trust’s assets are professionally managed, often in a mix of stocks, bonds, and other investment options. The goal is to ensure the fund grows enough to meet future retirement income obligations. If performance falls short, the employer—not the employee—must make up the difference.
Payout
When an employee reaches retirement age (typically between 62 and 65), the plan begins paying out their monthly annuity—or, in some cases, a lump sum. This payout is predetermined, not based on market performance.
Key factors that shape the final defined benefit plan payout include:
- Years of service: How long the employee worked for the company directly affects their benefit—the longer the tenure, the higher the payout.
- Salary history: Many plans calculate payouts based on the final average salary from the last three to five years.
- Plan type: Options include traditional pensions, cash balance plans, flat-dollar formulas, or final average salary formulas (more on these below).
- Retirement age: Retiring early may reduce benefits, while retiring later can increase them.
The Internal Revenue Service (IRS) oversees defined benefit plans, and in many cases, the Pension Benefit Guaranty Corporation (PBGC) acts as a safety net. If a company underfunds or terminates a plan—due to bankruptcy, for example—the PBGC may cover some or all of the promised retirement benefits.
Defined benefit plans vs. defined contribution plans and IRAs
Instead of defined benefit plans, many organizations today offer defined contribution plans like 401(k)s or individual retirement accounts (IRAs). But again, these options don’t guarantee a specific outcome. Employees manage their own investments and bear the investment risk—with no certainty about how much they’ll actually have when it’s time to retire.
Here’s how defined benefit plans compare to two retirement options your team likely already knows: 401(k)s and IRAs:
Is a 401(k) a defined benefit plan?
Not quite. While both are retirement plans, a 401(k) is a defined contribution plan, meaning the employer and employee contribute to an account, but the final balance depends entirely on market performance and personal savings. There’s no guaranteed outcome, and the investment risk sits with the worker—not the company.
In contrast, defined benefit plans provide stable, predictable income, regardless of how the market performs. For some organizations, especially those with long-tenured or leadership roles, that kind of certainty helps support long-term planning and retention.
Defined benefit plan examples
Not every defined benefit plan has the same structure. Here's an overview of four of the most common types—and how each one works.
Traditional pension plan
This is the most established type of defined benefit plan. Employees receive a lifetime monthly benefit based on a formula that factors in tenure and salary history. These plans are most common in government, education, and unionized sectors—industries where long-term employment is the norm:
1.5% × years of service × final average salary
Cash balance plan
Cash balance plans assign each employee a notional account that grows yearly based on pay and interest credits, both funded by the employer. While the structure resembles a defined contribution plan, the employer guarantees the final payout, keeping the investment risk in-house. This makes it a flexible option for companies seeking predictability without giving up control:
5% of salary (annual pay credit) + fixed 4% interest credit
Final average salary plan
This structure calculates retirement income using the average of an employee’s highest-earning years (again, usually the final three to five). It’s designed to reward long-term loyalty and retention, especially during an employee’s peak earning years.
2% × years of service × average of highest five years’ salary
Flat-dollar plan
This format offers a fixed annual benefit for each year of service, regardless of role or salary. It’s simple to manage, budget-friendly, and often used in settings with standardized compensation structures.
Flat-dollar amount (e.g., $100) × years of service
Pros and cons of defined benefit plans
Like any long-term retirement plan, defined benefit plans offer real advantages—but they also come with tradeoffs. Understanding both sides can help you decide whether a defined benefit plan is the right fit for your team:
Pros
- Attract and retain top talent: A defined benefit plan signals long-term stability. That matters for senior leadership or highly specialized roles where retention hinges on more than just salary.
- Simplify retirement for team members: Defined benefits reduce decision fatigue. There’s no need to manage investments or forecast savings—just a predictable monthly income to plan around.
- Enhance employer reputation: Offering a defined benefit plan demonstrates long-term commitment and organizational stability, which can strengthen your standing in competitive markets.
Cons
- Operationally complex and costly to maintain: Defined benefit plans require actuarial support, ongoing IRS compliance, and consistent funding—even during down markets.
- Limited portability: If an employee leaves before vesting, they may not receive full benefits. This can limit appeal for early-career or mobile professionals.
- Less flexible than modern alternatives: Defined benefit plans are less adaptable than profit-sharing or defined contribution plans, making them harder to customize for diverse, distributed teams with varied needs.
How defined benefit plans reinforce your compensation philosophy
For employers building global total rewards programs, defined benefit plans offer more than just retirement income. They signal long-range planning, shared commitment, and a level of trust that strengthens employee loyalty. They also help bring your compensation philosophy to life—not just in numbers but in values.
Here’s how:
- They reflect your compensation philosophy: A defined benefit plan communicates that your company values stability and sustainability over short-term rewards. That message resonates with mid-career and executive talent who are planning well into the future.
- They offer a global consistency layer: In distributed organizations, compensation parity can get tricky. A defined benefit structure provides a baseline benefit that balances regional retirement differences and helps create a more unified employee experience.
- They’re an alternative to equity-heavy models: In regions where equity isn’t common, a defined benefit plan offers a clear, tangible incentive without affecting your cap table or relying on fluctuating valuations.
Why defined benefit plans still matter
Defined benefit plans may feel like a thing of the past—but more companies are reintroducing them. For employers competing globally for long-term, high-impact talent, they offer a strategic edge.
Here’s what’s driving the shift:
- Defined benefits offer certainty: In volatile markets, guaranteed retirement income helps employers stand out as stable and future-focused.
- They reduce complexity: Employees don’t need to manage investments or second-guess how much to contribute monthly.
- They support long-term retention: For leadership and specialist roles, these plans encourage career investment and continuity—two things that equity alone can’t always deliver.
Offer competitive benefits with Oyster
Defined benefit plans may feel like a thing of the past—but more companies are bringing them back. For employers competing globally for long-term, high-impact talent, they offer a strategic edge.
These plans do more than ensure your employees are set for their golden years. They shape how people think about your company today—building trust, stability, and long-term alignment.
Oyster helps you bring that long-term value to life, offering the tools to integrate defined benefit plans into a broader global compensation strategy—without adding complexity.
Design global benefits that go the distance with Oyster’s Total Rewards. Book a demo to get started.
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About Oyster
Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.
Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.
