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Small Business Defined Benefit Plans


In these days of defined contribution plans (401k’s, IRA’s, etc…), why on earth would anyone use a defined benefit (aka:pension) plan for their retirement?  Well, there are some very good, yet very specific situations to consider this type of plan.

Most of these situations involve successful small business owners and entrepreneurs.  Very generally, this would apply to business owners making over $200,000 annually who want to put a high percentage of their money towards their retirement every year.  Most likely, this group of people would include professionals (doctors, lawyers, etc…) who are close to retirement and in their peak earning years, who have not been able to save as much as they would have liked in the past.  Typically, if the business has employees, the ideal situation would be that there are a small number of employees (1-2), and those employees are younger and make considerably less than the business owner.  The higher the employees’ salaries, the more costly the plan will be for the employer.

The great thing about the defined benefit plans is that they have potentially higher contribution limits than other plans.  So for those in “catch-up” mode, this is the best way to put money away on a tax-deferred basis.  As we discussed over the past few weeks, defined contribution plans are capped at $53,000 per year or below per individual. Defined benefit plans can have contributions well over $100,000.  This can result in very high savings levels, as well as very high tax breaks.

There are some other benefits to small businesses that use these plans, including employee retention.  Defined benefit plans can be funded on a profit sharing basis, and can vest over 5 years, which helps employee retention.  This plan can also be combined with other plans to put away an even larger percentage of money each year.

On the other hand, defined benefit plans can be complicated to set up, and costly to administer.  The plan benefits must be calculated by an actuary every year.  The other down side is that they need to be funded at a minimum level every year, so if cash flow is an issue from year to year for the business, this may not be a good choice.  This type of plan is a big commitment on the part of the business owner.

As you can see, there are big benefits to this type of plan, but the situation has to be almost exactly right due to the big risks in the plan.  If it sounds right for you, give us a call at 904.685.1505 to discuss your options.