A defined benefit plan is an employer-sponsored retirement benefit that provides workers, upon attainment of designated age and service thresholds, with a monthly benefit based on the employee's salary and length of service. The value of a DB plan benefit is not affected by the return on the assets that are invested to fund the benefit, although some DB plans in the public sector link post-retirement cost-of-living adjustments to investment performance. DB plans, also known as pension plans, are the central organizing element of the public retirement system community.
According to the U.S. Bureau of Labor Statistics, approximately 85 percent of employees of state and local government participate in a DB plan (this also includes those who participate in hybrid retirement plans); substantially all of the remainder participate in a defined contribution plan.
Public pension plans typically base the value of the benefits on a formula that includes the participant's final average salary, years of service credit, and a retirement multiplier. For example, an employee retiring with a final average salary of $60,000 with 20 years of service, participating in a plan with a retirement multiplier of 1.7 (1.7 percent per year of service) would be eligible for an annual pension benefit of $20,400: $60,000 x 20 x .017 = $20,400.
The retirement multiplier is a factor that determines the amount of a retired employee's annuity. The multiplier is usually determined as a percentage of final average salary (FAS) times years of service.
Service credit refers to an employee’s length of employment. Service credit is used both to determine an employee's eligibility for retirement (in most, but not all, plans) and to determine the amount of the participant’s benefit as calculated in the retirement formula. (In some cases, service credit can be purchased, usually with interest and for work performed with another employer and the retirement benefit for that work has been forfeited.)
Final average salary (FAS) refers to the method used by defined benefit pension plans to determine an employee’s salary for purposes of calculating a retirement benefit. FAS is sometimes referred to as final average compensation (FAC).
A 2008 study by the National Institute on Retirement Security found that a DB plan can pay the same benefit as a DC plan, at cost 46 percent lower than the DC plan. This is largely because DB plans pool longevity risks, rather than requiring plan participants to manage their own longevity risk. DB plans also enjoy greater returns on investment due to professional management and the advantages of economies of scale.
Decisions, Decisions: Retirement Plan Choices for Public Employees and Employers, Ilana Boivie, National on Retirement Security and Mark Olleman, Milliman (September 2011)