Small Business Defined Benefits Plan
By: VentureHow Staff Writer
Updated on: May 19, 2021
VentureHow.com Small Business Defined Benefits Plan is an overview of one of the retirement plan options available for entrepreneurs (and of course large companies.)
Defined benefit plans are employer-sponsored retirement plans, offering pre-established benefits for employees at retirement. Typically, these benefits vary based on salary, job title, number of years with the employer and a range of other factors, and defined benefit plans allow employers to contribute more than they can to defined contribution plans such as 401ks. However, these plans can be slightly more confusing. Wondering if defined benefit plans for small businesses are right for you? Here’s a look at the basics:
Small Business Defined Benefits Plan Basics:
Small Business defined benefit plans are where a specifically defined benefit is payable to employees after retirement. The small business defined benefit plans can work in conjunction with other retirement plans. For example, if you currently offer a 401k plan, you can provide to add a defined benefit plan to your offerings. Small businesses of any size can use defined benefit plans, so it doesn’t matter if you have five employees or 500 or even more — your company is eligible, regardless of its size.
However, there are no clear-cut thresholds for contribution limits, as there are with some other plans. Instead, you need to have an actuary determine the funding levels of your program. Annually, to be compliant with the IRS, your business needs to file Form 5500 along with Schedule B, and an actuary needs to sign it. Finally, with defined benefit plans for small business, you cannot retroactively decrease benefits, and that makes it critical to be committed to the benefits you decide to offer.
Pros and Cons of a Defined Benefit Plan for a Small Business
Defined benefit plans offer a host of advantages, but there are some downsides to these retirement plans. One of the main benefits of defined plans is that you, as an employer, can contribute more in a single year than you can with other methods. For example, the combined total of employee and employer contributions to 401k plans cannot exceed the higher of $53,000 or 100% of the employee’s annual salary, but the amount of contributions you can make to a defined benefit plan exceeds this amount.
Because you can contribute more, you can also deduct more like a business expense. For example, if you add $60,000 to a defined benefit plan on behalf of your employee, you can write off that amount as a business expense. Ultimately, that means that with a defined benefit plan, you have a stronger ability to reduce your tax liability than you do with other types of retirement plans.
Because you can contribute more to these plans, benefits can be provided and accrued in a relatively short period. Even if you promote early retirement among your employees, this savings vehicle still allows you to help them accumulate substantial benefits within a short period. These facts make defined benefit plans a useful tool to attract quality employees to your business.
Defined benefit plans for small businesses are not indexed to stock market gains or losses, and as a result, they provide a predictable benefit, which is ideal for retirees who want peace of mind as well as workers who want to prepare for their retirement. You can also create the vesting schedule you want, and allow your employees to be vested immediately or slowly over a period of up to seven years. For example, if you only want to offer full benefits to employees who have been with you for seven years, you can opt for a plan that vests participants slowly over time. As a result, if someone leaves your company after only two or three years of service, they will be partially vested and not subject to full benefits.
Finally, with a defined benefit plan, you can promote specific business strategies. In particular, if you want to subsidize early retirement, you can leverage your defined benefit plan to make that possible. That can be a useful tool if you need to downsize, and rather than letting anyone go, you want to encourage some of your staff to go into early retirement.
In spite of the host of advantages, there are also a few disadvantages to defined benefit plans for small businesses, and you should weigh them carefully before jumping into one of these plans. All of the positive elements of this retirement savings vehicle come at a premium, and unfortunately, it is the most costly plan you can implement in your small business. However, if a defined benefit plan is helping you to attract and keep great employees, the price associated with running the program may be well worth it.
Defined benefit plans are also the most administratively complex plans, and that fact can cause you to incur extra payroll expenses or consultancy fees. Finally, there are excise taxes in some cases– namely, if the minimum contribution requirement is not met or if excess contributions are made, your company will incur an excise tax.
Unlike other plans, there is no set formula or computation for deduction limits to defined benefit plans, and as a result, if you decide to use a defined benefit plan for your small business, an actuary will need to figure out your deduction limit. If you exceed that limit, you must pay a 10% excise tax on those contributions.
The Actuary’s Role in Small Business Defined Benefits Plan
To set up a defined benefit plan, you will need to work with an actuary. These professionals can help you set up the defined benefit plan and figure out your contribution limits. At the end of each year, you also need an actuary to sign the documentation you send to the IRS regarding your benefit plan.
Actuaries are financial professionals who use math, statistics and economic theories to determine the financial impact of specific events, and they apply these tools to the process of setting up your defined plan. In most cases, you don’t need to hire an actuary to work for your company. Instead, you may need to hire one on a consultancy basis for a few hours at a time. Ideally, you need to choose an actuary who is familiar with ERISA (Employee Retirement Income Security Act of 1974) and has to experience with retirement plans, and to that end, you may want to look for an Enrolled Actuary as they have completed training relevant to pensions.
Contributors
With many retirement plans, the employee makes the biggest contributions, and the employer matches a certain percentage of those contributions. With a defined benefit plan, however, you, the employer, make the most contributions. However, your employees may make required or voluntary contributions, depending on how you want to set up the plan.
Benefit Limits
When setting up the plan, your actuary can help you identify how much you want your employees to receive annually in benefits upon their retirement. There are generous limits to the annual benefits. As of 2016, the yearly benefits a participant can earn under a defined benefit plan is the lesser of $210,000 or 100% of the participant’s average compensation for his highest three consecutive calendar years.
If you want to make in-service distributions to an employee who is still working for you, you cannot do that until the employee is at least 62 years old. However, if you like, you can set up your plan so that participants can take loans from it as desired.
As an employer, it’s essential to offer your employees competitive benefits including retirement plan benefits. In some cases, a defined benefit plan may be perfect for your company, but in other cases, you may want to explore other options such as traditional or simplified 401k plans. In all cases, you should consult with an advisor to determine the best course of action.
PBGC Guarantee:
The assets held in a small business defined benefits plan (as well as all other defined benefits plans) are guaranteed by Pension Benefits Guaranty Corporation.
According to PBGC: “The Pension Benefit Guaranty Corporation (PBGC) protects the retirement incomes of more than 40 million American workers in nearly 24,000 private-sector defined benefit pension plans. A defined benefit plan provides a specified monthly benefit at retirement, often based on a combination of salary and years of service. PBGC was created by the Employee Retirement Income Security Act of 1974 to encourage the continuation and maintenance of private-sector defined benefit pension plans, provide timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at a minimum.
PBGC is not funded by general tax revenues. PBGC collects insurance premiums from employers that sponsor insured pension plans, earns money from investments and receives funds from pension plans it takes over.”
Small Business Defined Benefits Plans – Additional Resources
IRS Information about Defined Benefits Plans
Disclaimer: While VentureHow.com strive to provide quality information we cannot guarantee the accuracy or timeliness of updates. Retirement plan selection and set up is a complicated subject, mainly setting up a defined benefits plan. Please consult your accountant, attorney, actuary, and retirement benefits consultants to evaluate the applicability of a defined benefit plan for your company.