Defined Benefit Pension

How It Works

Defined benefit (DB) pensions promise retirees a formula-based benefit, typically 1.5-3% of final average salary per year of service. A 30-year employee earning $60,000 with a 2% multiplier would receive $36,000 per year (2% × 30 × $60,000). The employer bears the investment risk: if pension fund investments underperform the assumed rate of return, the sponsoring city must make up the difference with higher contributions, crowding out general fund spending on services. Most private-sector employers have abandoned DB pensions (only about 15% of private workers still have them per BLS National Compensation Survey), but DB plans remain the standard for roughly 75-80% of state and local government employees. The Public Plans Database tracks over 220 DB plans covering approximately 14.7 million active and retired public workers. Under GASB Statement 68 (effective FY2015), cities must report their proportional share of net pension liability on government-wide balance sheets, a significant change from pre-2015 practice that kept these liabilities in footnotes. This recognition added hundreds of billions of dollars in previously unreported liabilities to municipal balance sheets overnight. Illinois alone carries roughly $140 billion in state and local unfunded DB liabilities. Chicago's four pension funds (Municipal, Laborers, Police, Fire) collectively carry unfunded liabilities exceeding $33 billion. Detroit's 2013 bankruptcy imposed partial benefit cuts ("haircuts") on DB retirees for the first time in U.S. history, settling the legal question of whether pension benefits are protected in Chapter 9. DB pension funded status drives the 20% pension funding factor of the CitySpend Fiscal Health Score.

Related Terms

• Funded Ratio, The percentage of a pension plan's projected liabilities that are covered by current assets. A plan with $80 in assets for every $100 in liabilities has an 80% funded ratio.
• Unfunded Liability, The difference between a pension plan's projected liabilities (what it owes to current and future retirees) and its current assets. Also called the unfunded actuarial accrued liability (UAAL).
• Defined Contribution Plan, A retirement plan where the employer and/or employee contribute a fixed amount to individual investment accounts (like a 401k or 457b), with no guaranteed benefit amount.
• Actuarial Assumption, The financial and demographic projections used to calculate pension costs and liabilities, including expected investment returns, employee life expectancy, and salary growth.