3733 / What is a pension plan?

A pension plan is a qualified plan established and maintained by an employer primarily to provide systematically for the payment of definitely determinable benefits ( Q 3736) to its employees over a period of years, usually for life, after retirement. A plan can and must meet the requirement that the benefits be definitely determinable by providing for fixed benefits or fixed contributions.¹ Thus, a pension plan either can be a defined benefit plan or a defined contribution plan ( Q 3734).

Under a plan that provides fixed benefits (a “defined benefit” plan), the amount of the pension, or a formula to determine that amount, is set in advance; an actuary determines the annual contributions that are required to accumulate a fund sufficient to provide each employee’s pension when he or she retires. The size of an employee’s pension is usually related to the employee’s compensation, years of service, or both.

Under a plan that provides for fixed contributions (a “defined contribution” or “money purchase” plan), the annual contribution to an employee’s account (rather than his or her future pension) is fixed or definitely determinable, and the employee receives whatever retirement benefit can be purchased with the funds accumulated in the employee’s account. Usually the annual contribution is a fixed percentage of the employee’s compensation; in any event, it must not be related to the employer’s profits.² Contributions are not considered “fixed” where an employer intentionally overfunds a money purchase pension plan.³