The defined benefit plans have their own features. This means that it is very easy to recognize a defined benefit. For there is a certain amount paid to the employee when a specified time period is complete. Along with this various conditions also have to be fulfilled. There is no necessity of the payout being linked to the amount and kind of investment that is made in the scheme and the plan.
These schemes are a big relief for employees, as they will receive the payout no matter what are the conditions in the market and even if they turn bad the employee is protected. The final responsibility thus does not lie with them in these plans. If there is any shortfall in the amount to be paid out then the employer or the person managing the fund has to make the necessary arrangements to make the payout. Depending upon the plan and its nature, the various benefits will also change and vary.
For a person who wants to do the necessary planning they can take a look at the features of a defined benefit scheme and then make the necessary calculations on their own to get a good picture of the situation. However, these plans are slowly losing popularity among the employers.
One way to understand the operation of a defined benefit plan is by actually looking at such a scheme in operation. A very good example of this is the payment of gratuity. Leave salary and the employees pension scheme are other examples of a defined benefit plan. Under all these plans there is a law, which determines the type of benefits that a scheme will provide.
Consider the Payment of Gratuity Act. The presence of this Act means that the payment of gratuity is a necessity for most organizations. This has to be paid when the employee completes five years with an employer. Here, the payment is usually made as a certain month’s contribution for each completed year to the employee.
One has to understand that the gratuity payment from the company can be different from the calculation for the amount that is exempt from income tax. There is a separate calculation for the amount that will be exempt as there are several conditions to be fulfilled in determining the tax-free amount.
The defined benefit schemes have been present for a long period of time and for many, they have provided the way to providing for funds at the time of retirement. Since this has been followed since a long time a job with the government or state organizations was considered to be very safe and desirable as it gave a life-long protection.
The only problem was that over a period of time the system became unsustainable as the number of people who retired rose and due to this one has to provide sums for a larger number of people than what the various funds could support. A number of large organizations too adopted this system and are facing the same problem. A lot of them in the auto and the airline industry in the US are in trouble.
Earlier, the various parts of the capital market were also stable and there was an element of certainty in the whole issue. Now, on one hand the earnings are uncertain and at the same time the life span of people has also increased due to which the situation has turned on its head. The payments mechanism has become very difficult to meet the increased needs. There has been a re-look at the entire scheme of things by many entities and different alternatives are being adopted.