When people think about their overall retirement strategy, they often include plans such as 401(k)s and IRAs. Many overlook the possibility of using a defined benefit plan as an additional tool for reaching their retirement goals. Defined benefit plans are often misunderstood, considered a thing of the past or erroneously thought to be appropriate only for large corporations. Defined benefit plans can provide a very rich 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 promises to make specified benefit payments to qualifying employees at retirement.
There are Two Types of Defined Benefits Plans:
Pension Plans: A pension plan is a retirement plan in which participants are given a pre-determined 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 set percentage of his or her yearly compensation plus interest, and guarantees a contribution level and minimum rate of return.
Advantages of Offering a Defined Benefit Plan:
o Owners can contribute more than the 401(k) limits of $15,500/$46,000
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 an excellent way to provide retirement income to employees who have a short window before retiring (owners and mid-or late-career new hires)
o ERISA protects qualified plan assets from more creditors in the event of bankruptcy or lawsuit