Defined Benefit Plan Overview

Employers who do not require absolute discretion when determining the amount of their annual retirement plan contribution often establish Defined Benefit Plans. Typically, this is an employer whose annual profit picture does not fluctuate and therefore can commit to an annual required contribution. The contributions are then invested in the plan's trust account and used to pay benefits to participants at retirement, death, disability, or termination of employment.
The Defined Benefit plan is designed to pay a fixed benefit upon retirement. The benefit is based on the formula outlined in the plan document. The contributions are actuarially determined on the anticipated benefit at retirement. The factors that determine the total contribution are: Participants’ compensation; trust account earnings; participants’ ages; and years of service.
The plan sponsor bears investment risk because plan benefits don’t depend on contributions or investment results. If the assets fail to earn the rate of return used as the actuarial assumption, a greater contribution may be required the following year. Or, conversely, if the investments outperform expectations, the plan will have an actuarial gain, which may reduce future contribution requirements.

Advantages of Defined Benefit Plans:

• In many cases, allows for a greater tax-deductible contribution than other plan types.
• Provides higher benefits to older owners and/or key employees
• Provides a more significant benefit to older employees who are approaching retirement.
• Rewards employees who remain employed for many years.

Additional information pertinent to Defined Benefit Plans:

• Contributions are required to pay benefits determined by a formula set forth in the plan document.
• The annual compensation limit is $225,000 for plan years beginning in 2007 and $230,000 for plan years beginning in 2008.
• Participants are able to calculate what their future retirement benefit will be, though the mathematics can be complex.
• The annual benefit that may be paid to a participant is generally limited to the lesser of $185,000 in 2008 or 100% of the participant’s average compensation for the highest three consecutive years.
• The Internal Revenue Code requires that the employer meet annual minimum funding requirements.
• Depending upon the nature of the business sponsoring the plan, insurance premiums payable to the Pension Benefit Guaranty Corporation (PBGC) may be required.