Defined Benefit Plan
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
- Provides higher benefits to older owners
and/or key employees
- Provides a more significant benefit
to older employees who are approaching
- Rewards employees who remain employed
for many years.
Additional information pertinent to Defined
- Contributions are required to pay benefits
determined by a formula set forth in the
- The annual compensation limit is $270,000 for plan years beginning in 2017.
- 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 $215,000 in 2017 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
- Depending upon the nature of the business
sponsoring the plan, insurance premiums
payable to the Pension Benefit Guaranty
Corporation (PBGC) may be required.
- Please see our special addendum
additional information regarding cash
balance/defined benefit pension plans.
Cash Balance Plan Overview
The Cash Balance Plan had its genesis as
an innovative retirement plan designed and
created by Bank of America. The Bank wanted
a pension plan, but with a simulated account
balance that would appeal to its workforce.
Like a pension plan, the plan's assets would
grow by two (2) means: 1). a company
contribution, or pay credit, and 2).
investment earnings ("Interest Crediting
This pay credit was typically a set,
single digit percentage of the eligible
workers' annual pay, but it could be varied
on a periodic basis with proper advance
planning; while the interest credit concept
gives the employer much more flexibility in
setting this annual interest rate, with both
a "0 - floor", and "market rate of
return - ceiling".
Furthermore, under the September 2014
final regulations, the employer can tailor
its interest crediting rate (ICR) for
different cohorts of employees; much like a
401(k) participant would choose a target
date fund as an investment vehicle.
The Cash Balance plan provides the
1). Both the
Employer and the Employee appreciate the
ability to make much higher annual Employer
contributions on behalf of the Employer's
key professionals with an immediate income
tax deduction, but the costs to the Employer
are much less volatile, with more
predictable annual pension cost.
2). The Employer
appreciates that funding can be "Age
Neutral" such that a flexible contribution
amount can be made for business
partners/co-owners of varying chronological
Employees understand, and thus appreciate,
having a pension benefit denominated in an
account balance similar to the simpler
profit sharing plan.
4). As a result
of this original design and the follow-on
regulatory pronouncements, cash balance
plans are becoming much more popular than
traditional defined benefit pension plans,
and are growing rapidly in sheer number of
plans, aggregate number of plan
participants, and overall dollar assets
Of course, some unique rules apply to
Cash Balance plans such as the required 3
year vesting schedule, but the surge in the
implementation of Cash Balance Plans clearly
show that this concept is an attractive
option for those small and middle market
Employers who have a stable and profitable
cash flow, and a desire to maximize the
accumulation of retirement funds for key