A defined benefit plan promises to pay participants a specified monthly income at retirement. The amount of monthly benefits is usually based upon the participant's compensation and years of service. The maximum amount of annual retirement income is the lesser of the highest consecutive three-year average compensation or $205,000.
Contribution levels are determined by an actuary, based on actuarial assumptions about future pay increases, investment performance, years until retirement and life expectancy after retirement.
Contributions to a Defined Benefit Plan are mandatory and must satisfy minimum standards. Larger contributions must be made on behalf of older participants to fund a specified benefit level because an older participant has fewer years remaining until retirement.
Advantages
- Contributions for older business owners and key employees can be substantially higher in a defined benefit plan than in other types of retirement plans.
Possible Disadvantages
- The promised benefit must be provided to all participants regardless of the actual investment performance of the plan. Poor investment performance could result in increased contribution amounts from the employer.
- Termination of a defined benefit plan that is overfunded could result in an excise tax to the employer ranging from 20% to 50% on the amount of excess assets.
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