Defined Benefit Plan Rules and FAQs
What is a Defined Benefit Plan?
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. Factors such as a client's age, income, length of time before retirement and rate of return of the investment portfolio impact the required annual contribution amount. On an annual basis, an actuary makes calculations to determine the amount that needs to be contributed into the plan to ensure the target retirement income goal is reached.
How much can I contribute into a Defined Benefit Plan?
The amount that can be contributed annually is based on factors such as a client's age, income, length of time before retirement and rate of return of the investment portfolio. In 2013 the annual benefit payable at retirement can be as high as $205,000 per year. As a result, annual contributions into a defined benefit plan can be even larger than $205,000 in some cases in order to meet that level of retirement income target. On an annual basis, an actuary makes calculations to determine the amount that needs to be contributed into the plan.
What type of businesses are eligible for a Defined Benefit Plan?
Sole proprietorships, S and C corporations, LLCs and partnerships are eligible.
Who makes the contributions in a Defined Benefit Plan?
100% of the contributions are made by the employer. Contributions are generally 100% tax deductible (within IRS limits).
Small business owners with employees must make contributions for eligible employees. Employees do not contribute to a defined benefit plan. When a defined benefit plan is setup eligibility requirements can be established such as 1 year and a 1000 hours of service so part time employees that do not meet the requirement are not included in the plan.
I am the owner of multiple businesses. Do I have to cover employees in both businesses?
Yes, it is likely you would have to include employees in both businesses since you may be considered a "controlled group". Consult your tax advisor for details.
Are annual contributions mandatory?
Yes. A contribution is required each year to fund the predetermined retirement benefit amount at the specified future retirement date. The retirement benefit amount and retirement date are determined when the defined benefit plan is established.
Can a Defined Benefit Plan be amended if my income changes?
Yes. In general, you can amend the plan to increase or decrease the benefit formula. By amending the plan it will increase or decrease the annual contributions that need to be made. It may be viewed as abusive by the IRS if too many amendments are made. As a result, amendments should be infrequent.
What happens if I decide I want to retire and stop working prior to my Defined Benefit Plans specified retirement date?
In general, you can amend your plan and change the age of your planned retirement date. Also, if you want to work longer than you anticipated you may be able to amend your plan to extend your retirement date.
When can I retire and stop making contributions to the Defined Benefit Plan?
You can stop making contributions and terminate the defined benefit plan and rollover your plan into an IRA at any time. Prior to the plan being terminated, the actuary will run calculations and if there is a shortfall then a final funding may be necessary before the plan is terminated.
In general, these plans are expected to continue for at least 5 years and the earliest retirement date is age 55. If you feel you can't meet these conditions then you may not want to establish a defined benefit plan.
When must a Defined Benefit Plan be established?
The plan must be set up by December 31st or the end of your fiscal year.
What is the deadline for contributions to take a deduction for the current tax year?
Contributions must be made by your business's tax filing deadline for the current tax year (plus extensions), but no later than September 15th.
Can I contribute to a 401k plan and a Defined Benefit Plan?
Yes. You can make elective salary deferral contributions as well as have a defined benefit plan.
Are loans or hardship withdrawals allowed?
Hardship withdrawals are not permitted. Participant loans are available if you elect to have this feature when you adopt the plan. If you receive a loan from the plan, it may increase the annual contribution you are required to make into the plan.
What happens at retirement?
At retirement, at reaching age 62, or upon plan termination, IRS rules generally allow you to roll the assets into an IRA. In an IRA assets continue to grow tax-deferred. Another option is to purchase an annuity and start receiving periodic distributions. Income taxes must be paid when distributions are received.
Learn more about the benefits of the Defined Benefit Plan
- Defined Benefit Plan - Learn about how a Defined Benefit Plan works and learn who is eligible and a good candidate for a Defined Benefit Plan.
- Defined Benefit Plan Calculator - Use the calculator to show a comparison of how much could be contributed into a Defined Benefit Plan, Individual 401k, SEP IRA or SIMPLE IRA based on your income and age.
- Defined Benefit Contribution Limits - Learn about how contribution limits are determined in a Defined Benefit Plan.
- 401k Defined Benefit Plan - In addition to having a defined benefit plan you may be able to establish a 401k. A salary deferral may allow an additional $17,500 contribution ($23,000 if age 50+) in 2013.