So you have decided to start a defined benefit plan (also called a DB plan). But what is the process? In this post, we show you how to set up a defined benefit plan.
A business owner with an ambition to save more towards retirement as well as save on federal taxes will consider a defined benefit plan. Defined benefit plan works best for business owners and key employees with high-income levels.Quick Navigation
- How to Set Up a Defined Benefit Plan
- Get financial and tax advisers
- Third-party DB plan administrator (TPA)
- Prepare illustrations of plan contributions
- Draft plan documents
- Make contribution
- Starting a defined benefit plan
Contribution towards retirement is substantial especially for employees above 50 years of age. Defined benefit plan contributions can be as high as $100,000 for an employee earning a substantial income. As compared to a 401k plan, where limits are at approximately $50,000, this is, therefore, a huge boost for an accelerated retirement saving.
A tax deduction is another great advantage under a defined benefit plan. Contributions towards retirement are tax deductible for the employers. The deductions could be as high as $250,000 depending on the participant’s age and income level.
How to Set Up a Defined Benefit Plan
Under a defined benefit plan, a participant’s account earns a pay credit, normally 5% to 8% of salary each year, plus an interest credit applied to your account balance. When the plan reaches its time to distribute the funds, one can move their funds to another tax-advantaged account in order to defer tax until when they require the distribution.
A participant under a defined benefit plan receives a benefit defined by their account balance. Let’s take an example of a participant with $100,000 in the defined benefit plan account who has attained the age of retiring, that is 65 and he retires, he is entitled an annuity based on this balance, approximately $8,500 annually for his entire life.
Step #1 – Get financial and tax advisors
They will collect relevant employee information like age and income levels to be used to calculate the amount to be contributed for each employee by the employer. It is not necessary to include all employees, defined benefit plans favor business owners and key employees but you should ensure that IRS non-discrimination rule is met.
Step #2 – Third Party DB Plan Administrator (TPA)
As an employer, you will have huge responsibilities with the administration of a defined benefit plan as well as plan investments. TPA will help you handle the hefty administrative tasks and let you concentrate on ensuring return on investments.
Step #3 – Prepare an illustration
Ensure that your business has standards that will ensure annual contributions are made. You should also have a requirement for a regular review on plan returns and make regular changes on the interest rate or amend or freeze a plan before it becomes a liability to the company. The plan can also be terminated at any time and plan assets distributed to the participants.
Step #4 – Draft plan document
A legal document outlining all the db plan details, levels of contribution and interest rates to be used is drafted and signed by the end of a tax year the company wishes to start contributing.
Step #5 – Make Contribution
Ensure that your contributions are made by tax return due date. An extension can be obtained, but contributions should not go beyond eight and a half months after the year ends.
A defined benefit plan is the best pension plan for your company. It not only offers significant savings towards employee retirement, but it also offers a substantial tax deduction for the company.
Starting a defined benefit plan
We know that defined benefit plans can be complicated. That’s why we wrote this “how to set up a defined benefit plan” guide.
Constant cash flow is however required to ensure minimum frequent plan alterations which may prompt IRS to classify a plan as a deferral arrangement rather than a pension plan. A defined benefit plan also allows for the addition of a 401k and profit sharing plans for even higher contributions.