Unlike defined contribution plans (such as 401(k) plans and profit sharing plans) that do not typically provide a guaranteed level of benefit for the employees, DB plans rely on the employer to make required contributions on their employees’ behalf to provide a pre-determined benefit at retirement.
While DB plans have received some negative press in the past, they still offer great opportunities to small business owners to realize large, tax-deductible contributions. With higher allowable annual contributions available, DB plans are undoubtedly the best way to maximize retirement savings for individuals with a shorter horizon to retirement.
Characteristics of a DB plan
The number one attraction to a DB plan is that tax-deductible contributions for a participant can be higher than the limit of a defined contribution plan ($55,000 for 2018).
Each year’s contribution is based on the amount necessary to pay the participant up to 100% of income as an annual retirement benefit. That means, under a DB plan, a participant may be able to replace 100% of their monthly income upon retirement. The primary factors that determine the participant’s contribution are:
- Age of employee
- Length of service with the employer
- Number of years in the plan
- The benefit formula defined in the plan
When should you consider a DB plan?
Typical candidates for this type of plan are usually businesses with stable income and profits, where the owners or the key employees are older than the rest of the staff. DB plans also work for businesses such as:
- Consultants that work as independent contractors with high 1099-R incomes
- Attorney in an S-Corporation that historically received high wages and currently receives a lowered wage to minimize payroll taxes
- Part-time real estate agent with a working spouse who wants to contribute all the self-employment income to the plan
What are the pitfalls to avoid?
Larger deductions come with their own set of limitations. Successful DB plans require planning to ensure they run smoothly. Some points to consider before sponsoring a DB plan:
- What are the contributions to the plan that are required each year? Will my business have the income to support the required contribution each year?
- Will my deduction goals change year after year?
- How much flexibility do I want with my annual contribution?
To find out more about this type of plan, or to determine whether your business would benefit from sponsoring a DB plan, contact one of our Pension Consultants or complete our online Proposal Request Form. Your Pension Consultant can guide you to a plan that fits your idea of retirement.
DB Plan Executive Summary
Estimated First Year DB Contributions