Defined Benefit Plans
In defined benefit (DB) plans, the retirement benefit is defined as an annuity payable at retirement. Generally, this benefit is based on each participant’s compensation and years of service. Since these plans target a certain level of income at retirement, the interim contributions can be uncertain. An actuary is required to determine the minimum required and maximum deductible contributions each year.
The closer a participant is to retirement, the shorter the time available to fund the retirement income and therefore the higher the allowable contribution. This is one of the key advantages of a DB plan for a small business. It not only gives the business a much larger current deduction, it also allows the owner to accumulate greater retirement savings in a shorter period of time than other types of qualified plans. For a comparison of the potential contributions at different ages read our April 2019 Pension Trends Newsletter, or for more details about DB plans, visit our DB Plan FAQ page.
DB plans offer:
- Larger tax-deductible contributions compared to other retirement plans.
- Investment risk that is borne by the employer instead of the employees.
- The opportunity to make additional contributions in order to replenish investment losses.
- No need for current compensation in order to make current contributions.
- The ability to attract or retain employees by providing an employer-funded targeted retirement benefit.
- An allowable contribution range that can give plan sponsors a fair amount of flexibility.
- Several different plan types and designs that can be utilized to achieve a variety of plan sponsors’ objectives.
Types of DB plans include:
Cash Balance Plans
A cash balance plan is a type of defined benefit (DB) plan that looks and feels like a defined contribution (DC) plan, such as a profit sharing plan.
Floor Offset Arrangements
A floor offset arrangement is a defined benefit (DB) plan combined with a defined contribution (DC) plan such as a profit sharing plan to provide a total benefit.