A defined benefit plan is designed to provide a stream of income at retirement that is based on a predetermined formula. In some cases, the employee may have the option to choose either
a stream of income or a lump-sum payment at retirement. The employer is responsible for ensuring the plan is funded to provide the benefit defined by the terms of the plan. The annual contribution requirement is the amount necessary to fund the required benefit at retirement as calculated by the plan actuary. The responsibility of funding the benefit is up to the employer. This type of plan typically requires a substantial financial commitment; however, one of the advantages of a defined benefit plan is that it can offer a relatively large annual tax-deductible contribution for the employer.
WHAT IS A DEFINED BENEFIT PLAN?
Unlike other plans that allow a specific current contribution, a defined benefit plan provides a specific benefit at retirement. Annual employer contributions to the plan are mandatory, regardless of a business’ profitability. Businesses with an uneven or unpredictable cash flow should use caution when selecting a defined benefit plan.
HOW IS A DEFINED BENEFIT PLAN ESTABLISHED?
A defined benefit plan is established by adopting a defined benefit plan document. The plan document is typically provided by a third party administrator or financial institution and allows some customization in plan design. It is the employer’s obligation to ensure the plan is adequately funded.
HOW MUCH CAN BE CONTRIBUTED TO A DEFINED BENEFIT PLAN?
There is no specific limit on contributions to a defined benefit plan other than the amount necessary to actuarially fund the future benefit obligations of the plan. This amount can be much larger than contributions allowed under other plans; however, there is a limit on the annual benefit that may be paid from a defined benefit plan. For 2020, the benefit limit is $230,000 (indexed annually for inflation).
CAN I HAVE A DEFINED BENEFIT PLAN IF I AM THE ONLY EMPLOYEE IN MY COMPANY?
Yes. An owner employee can maintain a solo defined benefit plan.
3 STEPS TO ESTABLISH A DEFINED BENEFIT PLAN
STEP 1: Work with your financial professional or plan administrator to assist in establishing the plan and help with notifying employees of their eligibility.
STEP 2: With the help of your plan administrator, determine the desired retirement income benefit formula.
STEP 3: Work with your financial professional or plan administrator to determine how much should be added to the plan each year.
If you would like help in setting up a Defined Benefit Plan let us know.
Also, if you would like a no obligation, second opinion into your Defined Benefit Plan plan to see if your plan measures up give me a call at 630-799-8350 or email at info@crosspointwealth.com. We look forward to the opportunity to show where there may be inefficiencies and earn your business.
