====== Defined-Benefit Pension ======
A Defined-Benefit Pension (also known as a 'DB plan' or, in some regions, a 'final salary pension') is an employer-sponsored retirement plan that guarantees a specific, predictable monthly income to an employee after they retire. Think of it as a promise etched in stone. The employer commits to paying you a set amount for the rest of your life, regardless of how the stock market performs. The exact payout is calculated using a formula, which typically factors in your salary history (like your average pay over the last few years of work), your age at retirement, and the total number of years you've worked for the company. In this arrangement, the **employer** bears all the [[investment risk]]. They are responsible for managing a large pool of money, called a [[pension fund]], and ensuring it grows enough to cover all its promises to current and future retirees. This stands in stark contrast to its more modern cousin, the [[defined-contribution pension]] (like a [[401(k)]]), where the employee manages their own pot of money and the final amount depends entirely on their contributions and investment success.
===== How Does It Work? =====
The magic behind a DB plan lies in its formula. While each plan is unique, a typical formula might look something like this:
(1.5% Multiplier) x (Years of Service) x (Average of Final 3 Years' Salary) = Annual Pension
For example, an employee who worked for 30 years with an average final salary of $80,000 would receive:
1.5% x 30 x $80,000 = $36,000 per year, or $3,000 per month, for life.
To make sure the money will be there, companies hire specialists called [[actuary|actuaries]]. These mathematical wizards forecast how much the company needs to contribute to the pension fund each year. They consider factors like employee life expectancy, potential salary increases, and expected investment returns.
Before an employee is entitled to these benefits, they must complete a [[vesting]] period—a minimum length of service required by the employer, often around five years. Once vested, the employee has a legal right to receive their promised pension, even if they leave the company before retirement age.
===== The Investor's Angle: Why DB Plans Matter =====
For a value investor, a company's pension plan isn't just an employee benefit—it's a critical piece of financial analysis. A DB plan represents a massive, long-term [[liability]] on the company's [[balance sheet]]. Your job as an investor is to play detective and figure out if the company can actually afford its promises.
==== The Funded Status ====
The most important question is: is the pension plan //funded//? This means comparing the plan's assets (the money in the pension fund) to its liabilities (the total amount it has promised to pay out).
  * **Overfunded:** The plan has more assets than it needs to cover its obligations. This is a sign of financial strength, though rare these days.
  * **Underfunded:** The plan's liabilities are greater than its assets. This is a **major red flag**. An underfunded plan is like a financial anchor dragging on the company. It means the company must divert future [[cash flow]] to make up the shortfall—cash that could have been used for R&D, paying [[dividends]], or buying back shares.
Astute investors like [[Warren Buffett]] have famously highlighted the danger of "enormous, unfunded pension liabilities" that can turn a seemingly cheap stock into a value trap. You can find this crucial information tucked away in the footnotes of a company's [[annual report]]. Look for terms like "Projected Benefit Obligation" (the liability) and "Fair Value of Plan Assets." A big gap between the two should set off alarm bells.
===== The Decline of the DB Plan =====
If DB plans sound like a great deal for employees, it's because they are. Unfortunately, that's precisely why they have become an endangered species in the private sector. Companies have aggressively moved to shut down these plans for several reasons:
  * **Risk Shift:** Companies no longer wanted to carry the immense risk of guaranteeing investment returns for decades. They shifted this burden to employees through defined-contribution plans.
  * **Longevity Risk:** People are living longer, meaning companies are on the hook for making pension payments for many more years than originally anticipated.
  * **Low Interest Rate Environment:** Persistently low [[interest rates]] since the 2008 financial crisis have made it incredibly difficult for pension funds to earn the returns needed to meet their obligations, forcing companies to contribute more cash to plug the gaps.
While they are fading in the corporate world, DB plans remain common for government and public-sector employees. For investors, this means that when analyzing a classic industrial or "old economy" company, a deep dive into its pension health is not just good practice—it's an absolute necessity.