Business Owners: Save More for Your Own Retirement by Offering a Defined Benefit PlanSeptember 18, 2014
Defined benefit plans are making a comeback in popularity for certain employers.
Over the last few decades, the traditional pension or defined benefit plan has been on the decline, with 401(k) plans and other defined contribution plans becoming more common. Defined contribution plans can be more attractive to companies because they don’t depend solely on employer contributions and employees generally are the primary funders through salary deferrals.
However, defined benefit plans are making a comeback in popularity for certain employers: closely held businesses where the owners are significantly older than their employees.
The Defined Benefit Plan Benefit
For closely held business owners, especially those who have put off retirement planning, a major downside of defined contribution plans is that you may not be allowed to save as much as you need to retire. The 2014 combined limit on employer and employee contributions is $52,000 ($57,500 for participants over 50), and the maximum contributions to owners’ retirement accounts could actually be much less because of nondiscrimination rules.
Contribution limits for a defined benefit plan work differently. The plan sets a future benefit, and employer contributions are calculated actuarially based on what’s needed to reach that projected benefit. For 2014 contributions, the maximum future annual benefit is generally $210,000 (or 100% of average earned income for the highest three consecutive years, if less).
For older, highly compensated owners, the current contribution needed to reach their desired future retirement benefit may be much greater than the annual maximum contribution allowed to a defined contribution plan. With a defined benefit plan, an owner may be allowed to have a larger annual contribution made on his or her behalf that may be tax deductible by the company. And as long as employees are relatively young, employer contributions required on their behalf should be relatively small.
But it’s important to be aware that, unlike some defined contribution plans, defined benefit plans can’t reduce or suspend contributions in a bad year, and other restrictions apply.
There’s Still Time for 2014
You can make deductible 2014 defined benefit plan contributions as late as the due date of your tax return, as long as your plan exists on Dec. 31, 2014. Please contact Anthony Mangiarelli, CPA or any member of our Retirement Plan Services Group if you’d like more information about setting up a plan this year.