Design Elements of Defined Benefit Retirement Plans

The fundamental goal of retirement plan design is to meaningfully contribute to the retirement income needs of participants, consistent with the plan sponsor’s available resources. A defined benefit (DB) plan provides employees with a predictable retirement benefit for life. DB plans provide an established benefit formula defined by a legal plan document. The benefit formula is typically calculated by multiplying the benefit percentage based on the years of service times the final average compensation. DB plans vary in their calculation of benefits, which years and what types of compensation are included in the calculation. DB plans are funded by employee and employer (and, at times non-employer) contributions and investment returns. The investment related risks are typically borne by the plan sponsor. Separate best practices have been adopted for Defined Contribution Plans and Hybrid Retirement Plans, and they should be consulted accordingly.  

State and local governments should have a policy statement that will guide on-going plan design decisions.  

Once public plan sponsors develop a policy statement that will guide their plan design decisions, they need to decide upon the essential elements of the primary retirement vehicle. 

1. Key plan design considerations should include:
   1. The benefits to be provided by the plan. This may be identified as the intended income replacement level. Consideration may include future purchasing power retention for retirees through the use of other postretirement benefit adjustments, such as cost of living adjustments (COLAS).  
   2. Employee groups that will be eligible to participate in the retirement plan.
   3. For multiple employer plans, employers that are covered by the plan, and provisions for employers to withdraw from the plan, if allowed.  
   4. The vesting requirements for members of the plan. When and under what circumstance will members become entitled to some form of benefit? This should include a policy for the refund of employee contributions, if any, to members leaving the plan and the interest rate credited on those contributions. 
   5. Components of the formula to achieve desired benefits (benefit percentage, years of service, final average compensation and anti-spiking provisions). 
   6. Other benefit options such as early or disability retirement, joint and survivor options and lump sum withdrawals. 
   7. A determination as to whether the plan should include purchase of service provisions, such as prior military or other government service. 
2. Funding considerations. Funding sustainability is vital to the functioning of a DB plan. A plan must be funded in a sustainable manner to ensure its long-term viability and fiscal integrity. As a result, GFOA has dedicated an entire Best Practice to issues of funding (see Sustainable Funding Practices for Defined Benefit Pensions and Other Postemployment Benefits (OPEB) for details.) In addition, plan sponsors should consider the following: 
   1. Establish a funding policy that considers the plan's funding goals.
   2. Understand the key components associated with the cost of the plan, as determined through actuarial analysis. 
   3. Ensure manageable funding mechanisms are in place to meet the desired benefit levels. Determine the cost sharing strategy between the employer and employees, specifically if employee contributions will be participatory. Consider potential impacts of future actual or expected investment return experience. 
   4. The Board of Trustees should adopt an investment policy which contains the elements set forth in the GFOA Best Practice on Investment Fee Guidelines for External Management of Defined Benefit Plans. For additional recommendations on investment and allocation policies, consult the GFOA Best Practice on Asset Allocation for Defined Benefit Plans. 
   5. Have all benefit enhancements actuarially valued before they can be approved in order to ensure a complete understanding of their long-term financial impacts. Ensure that benefit enhancements are allowable by State law. 
3. Other plan design considerations should be examined, including:
   1. Board Governance. DB plans are usually governed by a Board of Trustees (Trustees). The selection of most public pension boards are commonly set by the governing statute or other authority establishing the public pension system. Trustees and staff have a fiduciary duty to administer the plan for the exclusive benefit of plan members (duty of loyalty) and must act in accordance with reasonable standards of prudence, regardless of other duties within the government. See the GFOA’s Best Practice on Governance of Public Employee Postretirement Benefits Systems. 
      1. Ethical Standards. Each Trustee and staff person that has fiduciary responsibilities should file annual reports certifying compliance with all required legal and ethical standards. 
      2. Education for Trustees. New Trustees should receive orientation training explaining their responsibilities and fiduciary duties as well as the responsibilities and fiduciary duties of the plan staff and the plan's agents (such as actuaries, outside investment managers and attorneys). A program of continuing education for Trustees and staff should be developed and encouraged. 
      3. Trustee and Staff Succession Planning. To ensure the continuity of sound Board governance, a program should be developed for a smooth transition of leadership positions.   
   2. Risk management. DB plan administrators and Trustees must adopt policies that address risk management, including investment, funding and operational risks. Actions taken by plan administrators and board members should identify, manage, and to the extent possible, control, or mitigate, these risks. Examples include asset liability modeling studies, actuarial audits, risk assessments, and periodic actuarial experience studies. 
   3. Legal Counsel. Experienced legal counsel should be retained to advise the Trustees on all legal matters, including possible securities litigation lawsuits or class actions, proposed changes to federal, state or local laws that might impact the plan, legal exposure to some forms of liability, loss of revenue through improper corporate activities and proper legal design of the plan to facilitate qualified status under the Internal Revenue Code. 
   4. Professional Services. Engage the services of experienced industry professionals, including, but not limited to, actuaries who can recommend sustainable funding policies and practices, investment managers who can manage and realize the plan's investment strategy, investment consultants who can help in establishing investment policies, conduct manager searches and evaluate performance, and a custodian, which is typically a bank or financial institution. Plans should minimize the influence of external parties, including governmental agencies and elected officials. 
4. Participant Education.
   1. Emphasize the purpose and goals of retirement planning, including the possibility of integrating the employer's DB plan with other potential retirement income sources, such as defined contribution savings plans, personal savings, and Social Security. 
   2. Develop participant education programs for employees to gain a better understanding of the benefits available from their retirement system. A summary plan description providing information on the retirement plan should be available to participants in a written document. For more information on this topic, please review the GFOA's Best Practice, Preparing an Effective Summary Plan Description. 
   3. Discuss retiree health care options and health insurance costs, including Medicare. 
   4. Provide tools, such as worksheet templates on estimating retirement benefits. 

Updated: January 2025