F.47.1 Defined Benefit Pension Plans

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1 A. Professional Conduct and Regulation

A.1 Code of Ethics and Standards of Conduct A.1.1 The Six Ethical Principles A.2 Procedural Rules and Discipline A.2.1 Fitness Standards for Candidates A.3 Financial Institutions Overview A.3.1 Broker-Dealers vs. RIAs A.4 SEC and Securities Regulation A.4.1 FINRA and Broker-Dealer Regulation A.4.2 State Securities Regulation A.5 Consumer Protection Laws A.5.1 Privacy and Confidentiality Requirements A.6 Fiduciary Duty and Application

2 B. General Principles of Financial Planning

B.7 The Financial Planning Process B.7.1 Establishing the Client Relationship B.7.2 Gathering Client Data and Goals B.8 Personal Financial Statements B.8.1 Key Financial Ratios B.9 Cash Flow Management B.9.1 Emergency Fund Planning B.10 Debt Management Strategies B.10.1 Mortgage and Home Financing B.11 Economic Concepts B.11.1 Planning for Inflation B.12 Time Value of Money Concepts B.12.1 TVM Calculations and Applications B.12.2 Loan Amortization B.13 Education Needs Analysis B.14 Education Savings Vehicles B.14.1 529 Plans In-Depth B.15 Education Funding Strategies B.16 Gift/Income Tax Strategies

3 C. Risk Management and Insurance Planning

C.17 Principles of Risk and Insurance C.17.1 Risk Management Process C.18 Analysis of Risk Exposures C.19 Health Insurance Fundamentals C.19.1 Types of Health Insurance Plans C.20 Disability Income Insurance C.20.1 Disability Policy Features C.21 Long-Term Care Insurance C.22 Annuities Overview C.22.1 Fixed vs. Variable Annuities C.23 Life Insurance Fundamentals C.23.1 Types of Life Insurance C.24 Business Owner Insurance Solutions C.25 Insurance Needs Analysis C.26 Insurance Policy and Company Selection

4 D. Investment Planning

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6 F. Retirement Savings and Income Planning

F.44 Retirement Needs Analysis F.44.1 Sources of Retirement Income F.45 Social Security Benefits F.45.1 Social Security Claiming Strategies F.45.2 Medicare Planning F.46 Eldercare and Special Needs Planning F.47 Qualified Plan Overview F.47.1 Defined Benefit Pension Plans F.47.2 Defined Contribution Plans F.48 Eligibility and Vesting F.48.1 Coverage and Discrimination Testing F.48.2 Contribution and Benefit Limits F.48.3 401(k) Plan Features F.49 Non-Qualified Deferred Compensation F.49.1 Executive Compensation Plans F.50 Retirement Plan Selection for Businesses F.50.1 Individual Retirement Accounts F.51 Distribution Rules F.51.1 Required Minimum Distributions F.52 Retirement Income Strategies F.52.1 Tax-Efficient Withdrawal Strategies F.53 Business Succession Planning

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8 H. Psychology of Financial Planning

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F.47.1 Defined Benefit Pension Plans

Key Takeaways Explain This Topic AI

DB plans promise a specific retirement benefit based on a formula; employer bears all investment risk

2026 annual benefit limit is $290,000 or 100% of average highest 3-year compensation (lesser of)

PBGC insures DB plans except for professional service firms with fewer than 25 employees

Three benefit formulas: flat amount, flat percentage, and unit credit (most common)

DB plans favor older employees who have less time to accumulate benefits

Mandatory funding required; actuary must be used annually to determine contributions
Last updated: October 2026

Defined Benefit Pension Plans

Defined benefit (DB) pension plans represent the traditional pension model where the employer promises a specific benefit at retirement based on a predetermined formula. Unlike defined contribution plans where the employee bears investment risk, in DB plans the employer assumes all investment risk and is responsible for funding the plan adequately to meet promised benefits.

Types of Defined Benefit Plans

There are two main types of defined benefit pension plans:

Traditional Defined Benefit Plans

Traditional DB plans calculate benefits using one of three formulas and pay benefits directly from a commingled trust. Participants have accrued benefits rather than individual account balances.

Cash Balance Pension Plans

Cash balance plans are a hybrid that combines features of both DB and DC plans:

Legally classified as defined benefit plans

Participants see a hypothetical account balance with guaranteed annual contribution rates and guaranteed earnings

Despite the account appearance, assets remain commingled
Requires an actuary annually (like traditional DB)
Uses 3-year cliff vesting (more accelerated than traditional DB)
Favors younger employees (unlike traditional DB plans)

Feature Traditional DB Cash Balance
Account Type Commingled, accrued benefits Hypothetical individual accounts
Favors Older employees Younger employees
Vesting 3-7 year graded or 5-year cliff 3-year cliff
Investment Risk Employer Employer
Actuary Required Yes, annually Yes, annually
Benefit Formulas

Traditional DB plans use one of three formulas to calculate retirement benefits:

1. Flat Amount Formula

Provides an equal dollar benefit to all participants regardless of salary or years of service.

Example: All retirees receive $1,500 per month.

2. Flat Percentage Formula

Provides a benefit equal to a percentage of salary , typically based on final average salary or career average salary.

Example: 50% of final average salary.

3. Unit Credit Formula (Most Common)

The most widely used formula, calculating benefits based on years of service multiplied by a percentage multiplied by salary :

Formula: Years of Service x Percentage x Average Salary
Example: 2% x 25 years x $100,000 average salary = $50,000 annual benefit

Formula Type Calculation Basis Example
Flat Amount Fixed dollar amount $1,500/month for all retirees
Flat Percentage % of salary 50% of final average salary
Unit Credit YOS x % x salary 2% x 25 years x $100,000 = $50,000
2026 Annual Benefit Limit

The maximum annual benefit that can be paid from a defined benefit plan under IRC Section 415(b) for 2026 is the lesser of :

$290,000 , or
100% of the participant's average compensation for the highest 3 consecutive years

This limit applies to the annual benefit payable at the plan's normal retirement age (typically 62-65). Benefits taken before age 62 or after age 65 require actuarial adjustments.

CFP Exam Note: The $290,000 limit is reduced by 10% for each year of plan participation less than 10, but never below 10% of the full limit.

Mandatory Funding and Actuary Requirements

DB plans have mandatory funding requirements :

Employer must contribute enough to fund promised benefits
An actuary must be used annually to determine required contributions

Actuary calculates the minimum contribution based on assumptions about investment returns, mortality, turnover, and salary increases

Funding rules were significantly modified by the Pension Protection Act (PPA) of 2006
PBGC Insurance

The Pension Benefit Guaranty Corporation (PBGC) provides insurance protection for participants in defined benefit plans:

PBGC guarantees payment of basic pension benefits if a plan terminates without sufficient assets
Employers pay premiums to the PBGC based on the number of participants and funding status

Exception: Professional service firms (doctors, lawyers, architects, etc.) with fewer than 25 employees are NOT covered by PBGC insurance.

PBGC Coverage Status
Traditional DB plans Covered
Cash balance plans Covered
Professional firms <25 employees NOT Covered
QJSA and QPSA Requirements

All pension plans (including DB plans) must offer:

Qualified Joint and Survivor Annuity (QJSA)
Default form of benefit payment for married participants at retirement

Provides an annuity to the participant for life, then continues to the surviving spouse (typically at 50% or more of the participant's benefit)

Can be waived only with spousal consent (notarized or witnessed by plan representative)
Qualified Preretirement Survivor Annuity (QPSA)
Provides an annuity to the surviving spouse if the participant dies before retirement
Automatically applies to vested participants
Can be waived only with spousal consent

Key Point: Profit sharing plans are NOT required to offer QJSA/QPSA unless they are the source of funds used to purchase annuities.

Commingled Accounts

Unlike defined contribution plans with separate individual accounts:

DB plan assets are held in a single commingled trust
Participants have accrued benefits , not account balances
Investment gains/losses affect employer funding requirements, not participant benefits
The promised benefit remains the same regardless of investment performance
Who DB Plans Favor

Defined benefit plans generally favor older employees because:

Older employees have less time for contributions to grow through compound interest
The actuarial cost of providing a given benefit is higher for older employees (less time to fund)
Employers must contribute more per year for older employees to reach the same benefit level
Credit can be given for prior service (not possible in DC plans)

Employee Age DB Plan Impact DC Plan Impact
Older (50+) Favored - higher employer cost per dollar of benefit Less favored - less time for compound growth
Younger (<35) Less favored Favored - more time for compound growth
Social Security Integration

DB plans can integrate benefits with Social Security using two methods:

Offset Method (DB Plans Only)
Reduces the retirement benefit by a portion of the participant's Social Security benefit
Only available to defined benefit plans
Effect: Higher-paid employees receive relatively larger plan benefits
Excess Method (DB and DC Plans)
Provides higher contributions or benefits for compensation above the Social Security wage base
Available to both DB and DC plans

CFP Exam Tip: Only DB plans can use the offset method . Both DB and DC plans can use the excess method .

Key Characteristics Summary

Characteristic Defined Benefit Plan
Annual Benefit Limit (2026) Lesser of $290,000 or 100% of 3-year average comp
Investment Risk Employer
Account Type Commingled (accrued benefits)
Mandatory Funding Yes
Actuary Required Yes, annually
PBGC Coverage Yes (except professional firms <25 employees)
QJSA/QPSA Required Yes
Favors Older employees
Prior Service Credit Allowed
Social Security Integration Offset method or Excess method
Vesting (non-top-heavy) 3-7 year graded or 5-year cliff