When people think about their overall retirement strategy, they often include plans like 401(k)s and IRAs. Many overlook the possibility of using a defined benefit plan as an additional tool to reach their retirement goals. Defined benefit plans are often misunderstood, considered a thing of the past, or mistakenly thought to be appropriate only for large corporations. Defined benefit plans can provide a valuable retirement planning tool for small business owners, allowing them to maximize their contribution up to $200,000 or more.
What is a Defined Benefit Plan?
Defined benefit plans are retirement plans in which the employer agrees to make specific benefit payments to qualified employees at the time of retirement.
There are two types of defined benefit plans:
Pension Plans: A pension plan is a retirement plan in which participants receive a predetermined monthly benefit amount provided they meet certain requirements. Monthly benefits are calculated based on age, years of service and income. An employer must maintain the plan at an adequate funding level to meet future benefit obligations.
Cash Balance Plans: A cash balance plan is a hybrid of defined benefit and defined contribution plans. An employer credits a participant’s account with a fixed percentage of their annual compensation plus interest, and guarantees a minimum contribution level and rate of return.
Advantages of Offering a Defined Benefit Plan:
o Owners can contribute more than the $15,500/$46,000 401(k) limits
o Owners have the option to overfund contributions (150%) in a good year
o Provides a powerful tool to retain high-quality employees
o Allows for larger tax deductions compared to a defined contribution plan
o Employer contributions can be taken as a business expense deduction
o Allows for a great way to provide retirement income for employees who have a short window before retirement (owners and new hires in the middle or end of their career)
o ERISA protects qualified plan assets from more creditors in the event of bankruptcy or lawsuit
