Curtis knows that when he retires, he will receive $100 a month for every year of service with his employer. This is an example of Select one:
a. a defined-contribution plan
b. a profit-sharing plan
c. a money purchase plan
d. a defined-benefit plan
The correct answer and explanation is:
The correct answer is d. a defined-benefit plan.
A defined-benefit plan is a type of retirement plan in which the employee’s future retirement benefits are predetermined based on a specific formula, often linked to factors such as years of service, salary history, or age at retirement. In Curtis’s case, he will receive a fixed monthly amount of $100 for each year of service with his employer. This is characteristic of a defined-benefit plan because the benefits are clearly defined ahead of time and are not dependent on the amount of money contributed to the plan or the investment performance of the plan’s assets.
In a defined-benefit plan, the employer typically assumes the investment risk, as they are responsible for ensuring that enough funds are available to meet the promised future benefits. The amount that Curtis will receive in retirement is predetermined and does not fluctuate based on the performance of the investments in the retirement plan. This contrasts with a defined-contribution plan, where the retirement benefits depend on the contributions made to the account and the investment returns.
For comparison, a defined-contribution plan (option a) does not promise a specific retirement benefit. Instead, it defines the amount the employee or employer will contribute to the plan, and the employee’s final benefits will depend on the performance of the investments in the account.
A profit-sharing plan (option b) allows employees to share in the profits of the company, but the amount received typically varies based on the company’s performance, not on a predefined formula.
A money purchase plan (option c) is another form of defined-contribution plan where the employer makes fixed contributions to the employee’s retirement account, but the benefit at retirement depends on the contributions and investment performance, not a fixed amount based on years of service.
In summary, Curtis’s plan is a defined-benefit plan because his retirement benefit is a fixed amount based on his years of service.