Defined benefit plans are more expensive to set up and to maintain. A one person defined benefit plan can be as low as $0 setup and $1,000 annual fee.
Depending on the age and income of the business owner, annual contributions can potentially be $100,000 to $250,000 or more per year. Loans may be permitted, however this may increase annual funding requirements.
What are the disadvantages of a Defined Benefit Plan?
Defined benefit plans are more expensive to set up and to maintain. A one person defined benefit plan is $0 setup and $1,000 annual fee.
Defined benefit plans have mandatory annual funding requirements. Annual contributions to a defined benefit plan are not discretionary like they are with a Solo 401k or SEP IRA.
What are the advantages of a Defined Benefit Plan?
In general a defined benefit plan is appropriate for a business owner age 40 or older who would like to make tax deductible contributions in excess of the maximum limits of the Individual 401k or SEP IRA. Defined benefit plans offer substantial tax deductible retirement contributions and significant future retirement income. Depending on your age and income the annual contribution to a defined benefit plan can exceed $100,000. However, for high income earners a defined benefit plan can be appropriate by age 30.
Defined benefit plans have greater administrative fees and more rigid annual funding requirements, but may be ideal for business owners who want to maximize their annual retirement plan contributions
How does a Defined Benefit Plan work?
A defined benefit plan is a qualified retirement plan in which annual contributions are made to fund a chosen level of retirement income at a predetermined future retirement date. Contributions are made according to an actuarial formula to meet the target retirement income benefit. In 2021, the annual benefit payable at retirement can be as high as $230,000 per year. As a result, annual contributions into a defined benefit plan can be even larger than $230,000 in some cases in order to meet that level of retirement income target. There are a number of factors involved with this calculation.
How are the contributions into a Defined Benefit Plan determined?
Calculating the annual dollar amount that can be contributed requires a mathematical calculation performed by an actuary involving the following factors:
- Client’s age – In general, the older the client then the larger the annual contribution that can be made into the plan.
- Client’s income – The calculation is based on the average of the client’s highest 3 years of income. The greater the income then the greater the annual contribution can be (up to certain limits). Depending on a client’s income, the annual benefit payable at retirement can be as high as $230,000 per year in 2021.
- Planned retirement age – In general, at least 5 years from the year the plan is adopted.
- Investment performance – In the years after the defined benefit plan has been established an annual actuarial calculation is made based on the performance of the investments in the plan. The actual performance of the portfolio can impact the annual contribution amount that will need to be made so therefore having a portfolio that minimizes volatility is often prudent. When a defined benefit plan is established there is a rate of return assumption that is factored into the actuarial calculation to determine the annual contribution amount that is necessary in order to fund the future retirement income benefit. Each year the actual return of the portfolio will be compared to the rate of return assumption. When the portfolio’s actual return is greater than rate of return assumption then there will be a smaller required annual contribution. Conversely, when the actual return is less than the rate of return assumption then the annual contribution will need to be increased to make up the shortfall. On an annual basis, an actuary makes calculations to determine the amount needed to be contributed into the plan to ensure the future target retirement income goal is reached.
The calculations of how much can be contributed to a Defined Benefit Plan can be a little tricky to understand, but contact us and we would be happy for you to speak with an actuary regarding your situation or to run a customized Defined Benefit Plan proposal for you based on your income.
Defined Benefit Plan Calculator
Utilize the Defined Benefit Calculator below to give you an idea of how much you could contribute. Keep in mind, the calculator is for illustrative purposes and is an estimate. There are certain plan design options such as adding a 401k salary deferral option to the Defined Benefit Plan that can potentially increase the annual contribution amounts beyond what this calculator is showing.
Use the calculator to show a comparison of how much could be contributed into a Defined Benefit Plan, Individual 401k, SEP IRA and SIMPLE IRA based on your income and age.
Note: If you are taxed as a sole proprietorship use your NET income when using the calculator. If you are incorporated, then only use your W-2 wages when using the calculator. For example with an S corporation K-1 distributions (corporate profits) are not included in the calculation only W-2 wages.
Who is a good candidate for a Defined Benefit Pension Plan?
- May be ideal for self employed individuals and small business owners with high earned income.
- In general age 40 or older. However, for high income earners a defined benefit plan can be appropriate by age 30.
- Clients who would like to maximize their retirement contributions in excess of the limits of the Individual 401k or SEP IRA.
- Clients with stable and predictable income (because of the large tax deductible funding commitment). You are obligated to make annual contributions once your plan is established. Funding a defined benefit plan involves a commitment to invest significant amounts each year for the life of the plan. Within certain IRS limits, clients can decide how much of their current income they can comfortably afford to contribute to the plan, but once this annual contribution amount is established then funding a defined benefit plan is fairly rigid and must be made annually.
Defined benefit pension plans may be beneficial to older employees who feel they are behind with their accumulated savings for retirement and need (or want) to make significant contributions to accumulate assets rapidly over a relatively short period of time.
Another scenario when a defined benefit plan may be a good choice is for a dual income household, with one spouse that is self employed, and is in the fortunate position of being able to live off of one income. As a result, they may be able to afford to make a retirement contribution using a significant portion the self employed spouse’s income into a defined benefit plan.
Another scenario when a defined benefit plan may be a good choice is for someone who is working full time with one employer and then has a separate self employed one person consulting business. This individual may be able to contribute a significant portion of their self employed income into a defined benefit plan.
A partial listing of some of the occupations that might qualify
- Financial Planners
- Graphic Designer
- Independent Corporate Director
- Independent Insurance Agent
- Manufacturer’s Rep
- Mortgage Broker
- Real Estate Agent
- Software Developer
Receiving a Defined Benefit Pension Plan Proposal
Complete this contact form and we would be happy for you to speak with an actuary regarding your situation or to run a customized Defined Benefit Plan proposal for you based on your income. Beacon Capital Management Advisors provides defined benefit plan services to small business owners and to corporations ranging from 1 to 1,000 employees