What defines a defined benefit pension plan?

A defined benefit pension plan is characterized by the promise of a specific retirement benefit that is predetermined, typically based on factors such as salary history and years of service. In this type of plan, the employer is responsible for ensuring that enough funds are available to pay the promised benefits to employees upon retirement. This guarantee provides a stable source of income for retirees, as they will receive a specific amount regardless of investment performance or other fluctuations in the market.

In contrast to defined contribution plans, where the retirement benefit depends on the contributions made and the performance of the selected investments, a defined benefit plan shifts the investment risk to the employer. This means that the employer must manage the plan's investments effectively to meet its obligations to its employees.

Understanding this concept is crucial, especially in the context of retirement planning, as it highlights the security offered by defined benefit plans in comparison to the uncertainties of investment-dependent plans.