A defined benefit plan provides for a fixed, pre-established benefit for employees at retirement. Those plans provide for a very predictable benefit. In a profit-sharing plan, the amount you end up with at retirement is a combination of contributions, earnings and probably a little bit of luck.
Defined Benefit Plans and the IRS
You’re hoping to save and earn enough. In a defined benefit plan, you have a fixed amount at retirement. The amount the employer has to contribute each year depends on the projected benefits and the trust earnings. If the earnings are very good, the contributions will be lower; and poor earnings will mean more contributions.
Defined Benefit Plan Retirement Compliance
These plans are much more complex and more costly to establish and maintain than any other type of plan. They also have a required employer contribution each year. Contributions are not discretionary. These plans employ an actuary to determine the benefits being earned and the yearly funding requirement of the plan. Many have an investment team to monitor and select investments.
Defined Benefit Plan Benefits
A defined benefit plan can provide substantial benefits and they can accrue within a very short time. You’ll find some of the largest deductions for contributions made to a defined benefit plan. And just like the profit-sharing and 401(k) plans we discussed earlier, the plan must cover all employees age 21 who work at least 1,000 hours of service during the plan year. These plans also have a Form 5500-series filing requirement. There’s also a Schedule B that the actuary is going to have to complete and sign. You’ll find that most defined benefit plans are sponsored by larger companies, government employers, and very small businesses with large cash flows. During my audit days, it was really common to see a defined benefit plan with a doctor in their 50s. They have a short time left until retirement, so they’re able to contribute and deduct very large amounts into those defined benefit plans.
Company Sponsoring a Defined Benefit Plan
A business that sponsors a defined benefit plan is also allowed to have another plan. And since a defined benefit plan generally will have a required contribution each year, it is typical to see companies that have very stable incomes and cash flows have those plans. And when you look at the pros and cons of those, the biggest pro is that these plans provide a predictable benefit at retirement. In a plan that has participant accounts, you’re saving money, and whatever it grows to is what you have. In a defined benefit plan, if you decide you want to replace 80 percent of your compensation in retirement, you can set up a defined benefit plan with a formula that provides 80 percent of your compensation. So, you then just make the contributions each year that are required by the actuary. And they’ll grow to accommodate that monthly income.