A defined benefit plan is the equivalent of the pension many ‘older’ employees have enjoyed during retirement. Today, you see more defined contribution plans or 401Ks which require your own contributions and don’t have any type of guarantee.
The defined benefit plan has many benefits that many small business owners overlook. In this guide, we walk you through the definition of a defined benefit plan and help you see how it may help you.
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Understanding the Defined Benefit Plan
A defined benefit plan means that you take control of your employees’ retirement income. Rather than employees contributing to their own plan, you pay into it based on your predetermined formula. The formula usually consists of:
- The amount of the employee’s salary
- The age of the employee
- The time spent at the company
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Upon the specified retirement age, employees can then withdraw from the company-paid plan. It doesn’t matter how the market is doing at the time or any other factors. The employee has the right to withdraw the funds he/she is entitled to, leaving the brunt of the stock market risks on the employer. While this sounds harsh, the long-term aspect of the defined benefit plan helps offset the immediate risk of a market downturn – it’s about long-term investments and riding out the peaks and valleys.
How Defined Benefits Plans Pay Out
You can choose how your employees’ defined benefit plans payout. Most employers offer:
- Single life annuity – You receive a fixed amount each month from the date you retire until the date that you die. Once you die, the payments stop – your beneficiaries don’t receive the income.
- Survivor annuity – You receive a fixed amount each month from the date you retire until the date that you die. Your qualified spouse or survivor will continue to receive up to 50% of the payments until he/she dies.
- Lump-sum – You can receive the entire value of your defined benefit plan at once, investing it as you see fit.
The Benefits of Offering a Plan
As a small business owner, you have to worry about your own retirement plan as well as those of your employees (if you want to offer value-added benefits). While many business owners offer the defined contribution plan (401K), there are benefits of offering a traditional pension or defined benefit plan.
Attract more Talented Employees
It’s a tough market out there today. Finding the right employees can seem impossible. If you are looking for top-quality talent, you need to provide value that other employers don’t offer, such as the defined befit plan. Employees that know employers will invest in them are more likely to come to your company rather than go somewhere where they have to invest in themselves.
Keep Employees Longer
Job stability today is uncommon. The minute an employee is unhappy, they start looking for another job. That makes it hard for small businesses to succeed. Turnover is expensive and time-consuming. When you offer a defined benefit plan, it encourages employees to stick around longer, knowing that their retirement benefits will increase as a result.
Defined contribution plans can be set up in many ways, but one of the most popular is with profit sharing. The more your company makes the more money your employees get in their retirement fund. What does this do for employees? It makes them want to work harder because they have a vested interest in the company’s profits.
Contribute More to Your Own Retirement
If you’re self-employed, chances are that you haven’t contributed to your own retirement quite yet. Even if you have, it may not be enough. If you’re trying to play catch-up, a defined benefit plan offers much more flexibility. You aren’t restricted by low 401K plan limits, as defined benefit plans allow contributions as much as four times what you can contribute per year in a 401K.
How are a Defined Benefit Plan and Defined Contribution Plan Different?
Today, most employers offer the defined contribution plan (401K) because it’s much cheaper for them, but as we discussed above, there are sacrifices. With a defined contribution plan, there’s less of a need for employee loyalty or even draw to work at your company. But because it’s the norm, many companies still offer the defined contribution plan rather than a defined benefit retirement plan.
The differences include:
- Employees determine the portion of their income that they’ll invest in their retirement. In a defined benefit plan, you the employer, take the brunt of the responsibility.
- You can decide how much (if any) you want to contribute to your employees’ plans. Most employers offer a match up to a certain percentage of the employee’s income, such as a 2% match.
- Employees direct the investments. Each plan has its own options, but employees get to choose within those options how his or her money is invested.
- You have no direct responsibility for the account. The employee is responsible for the direction of the funds and managing the portfolio with the plan administrator.
Defined Benefit Retirement Plan
Should you offer a defined benefit plan rather than a defined contribution plan at your small business? It’s an important decision. First, take a look at your own situation. Have you saved for retirement or are you well behind? If you are behind, you may do yourself and your employees a favor by starting a defined contribution plan. Not only will you help your employees get the retirement funds they need, but you can fund your own retirement.
Even if you aren’t looking for ways to enhance your own retirement, but need to attract and keep quality employees, the defined benefit plan can be a great way to do it. It’s not a benefit employees find very often any longer and it shows that you’re investing yourself in your employees. This shows that you care about more than your profits, but that you truly care about those that help you grow your business.