Defined Benefit Pension Plan

What is a Defined Benefit Pension Plan?

Defined Benefit Pension Plans have been around for a long time. Back in the 1960's many people worked for the same employer until they retired. Often, the company provided a benefits package that included a Defined Benefit Pension Plan. When asked about the plan, the personnel manager or the plan administrator explained that after reaching retirement age, the employee could count on a monthly retirement income for the rest of their life equal to a percentage of their final average pay. For example, the plan may have offered a benefit of 50% of final average salary. If the employee had average salary of $2,000 per month, they could count on receiving a monthly benefit of $1,000 for the rest of their life. As you can see, the plan Defines the employee’s retirement benefit, hence the name Defined Benefit Pension Plan. Since benefits are promised at retirement age, the company must make adequate contributions so there are sufficient assets to pay future benefit obligations.

Who Should Consider a Defined Benefit Pension Plan?

Generally, small consistently profitable companies, especially if there is a desire to fund high benefits over a short period of time.

Why would a Defined Benefit Plan work for a Small Profitable Company?

Because the plan will enable the company to contribute a very high percentage of pay for participants who are at least age 48. Why? Because there is a short period of time to fund high fixed benefits. Although the normal form of benefit payable at retirement age is an annuity payable for life, many participants elect a lump sum optional form of benefit and roll over their benefits to an IRA. In general, a Defined Benefit Plan allows the employer to fund for a lump sum retirement benefit of as high as $2,300,000 or more per participant provided average salary is high enough. For example, the participant who earns $200,000 annually and is age 55 will require large annual company contributions in order to eventually walk away with a lump sum benefit of $2,300,000 in 10 years. In contrast, an employee who is age 30 will not require large contributions because the company would have 35 years to fund for a fixed benefit and during that time, plan earnings will fund a substantial portion of eventual retirement benefits.

Additional Considerations

Some employers are excellent candidates for a Defined Benefit Pension Plan but do not want the full obligation to fund such a high contribution every year. Often, this problem can be solved by pairing a Defined Benefit Plan with a 401(k) plan. In a bad year, the employer can fund the Defined Benefit Pension Plan and possibly fund no contribution to the 401(k) plan.

Multiple plan design opportunities exist to allow a Defined Benefit Pension Plan to be very beneficial and cost effective.

Please contact us if you are interested in discussing this type of plan for you and your employees.