Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

Which type of retirement plan makes distributions based on a predetermined formula?

1. Defined contribution plan

2. Defined benefit plan

3. Self-directed plan

4. Cash balance plan

The correct answer is: Defined benefit plan

A defined benefit plan provides retirement income based on a predetermined formula that typically considers factors such as the employee's years of service, salary history, and retirement age. This type of plan is structured to offer employees a certain amount of benefits upon retirement, calculated in advance and guaranteed by the employer. In contrast, a defined contribution plan, such as a 401(k), is based on the contributions made by the employee and possibly the employer, but the benefits received upon retirement will vary depending on investment performance and total contributions made over time. Self-directed plans allow participants to choose their own investments but do not guarantee a specific benefit amount at retirement. Cash balance plans are a hybrid between defined benefit and defined contribution plans, offering a guaranteed annual contribution credited to the participant’s account, but the benefit at retirement is still based on a predetermined formula rather than purely individual contribution amounts. Thus, the characteristic feature of a defined benefit plan is its reliance on a fixed formula for calculating retirement benefits, making it distinct from other types of plans.