Defined benefit plans have a growing presence in the lives of small business owners. But how much do most people know about them?
While these plans are a favorite of small business owners, they come with a lot of complexity.
In this post, we will detail the advantages of defined benefit plans. We will also offer up a few pitfalls.
Table of contents
- Defined Benefit Plans are Straightforward
- You can Contribute More
- Employers can set the Vesting Period
- You can Have a Defined Benefit Plan and IRA
- Employers get a Tax Break
- Employees may Access the Funds Early
- Don’t Rely on how Investments Do
- Defined Benefit Plans Encourage Employee Loyalty
- Defined Benefit Plans Encourage Employees to Work Hard
- Defined Contribution Plans Benefit both the Employer and the Employee
- Advantages of Defined Benefit Plans
While a majority of the focus today is on 401K plans or defined contribution plans, many small business owners are finding the advantages in sticking with the old-fashioned pension plans.
Paying into your employees’ retirement plan based on a set formula and bearing the risk for your employees sounds risky at first, but it has its benefits. Check out the top ten advantages of setting up defined contribution plans for yourself and your employees below.
Defined Benefit Plans are Straightforward
There’s no guessing how much retirement income an employee will have come retirement. There isn’t a lifetime limit. Retirees along with their employers work together to choose a payout plan whether a lump sum or annuity. The payments are structured so that employees don’t outlive their plans or payouts.
You can Contribute More
As a business owner, you may have put your own retirement needs last. As you built your business or just get ahead in life, you may not have saved for retirement. With defined contribution plans, you have much lower contribution limits, unless you are over 50-years old, at which point you get an additional $6,000 catch-up allowance. With a defined benefit plan, the limits are as much as 4 xs higher and the limits increase as you age.
Employers can set the Vesting Period
You can set your own vesting period, which can be up to seven years. Employers can choose between cliff vesting, which sets a specific number of years of service before an employee is vested (such as 3 years) or graduated vesting, which gives employees partial vesting each year starting with year 3, until you are fully vested at year 7.
You can Have a Defined Benefit Plan and IRA
If you want to further your retirement benefits, you can contribute to an IRA (both employees and employers). Whether you qualify for the tax deduction for contributing to an IRA may differ, though. It depends on your income level at the time. If you qualify for a Roth IRA, you may be better off taking the tax benefits upon retirement rather than losing them now with a traditional IRA.
Employers get a Tax Break
Employers that make pension contributions may write the contributions off on their taxes. This helps reduce an employer’s taxable income while providing a benefit to its employees and the tax break is often much larger than any other retirement fund for employers. Employees don’t have to pay taxes on the income until they withdraw it during retirement.
Employees may Access the Funds Early
The typical retirement age for a defined benefit plan is 65-years old, but you may retire early, sometimes as early as 55-years old. It depends on the plan’s rules. Keep in mind that you’ll receive a lower payout if you retire earlier than full retirement age, so make sure you crunch the numbers and ensure that you’ll have enough for your expected lifetime. Some employees retire early out of necessity and cashing in their pension fund is the only way to ensure financial resiliency at the time.
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Don’t Rely on how Investments Do
Unlike your 401K or IRA funds, pension funds don’t rely on how an investment performs. Defined benefit plans have guaranteed payouts. You don’t have to worry about how the market performs – your retirement funds are guaranteed, which means you’ll know beyond a doubt what you’ll receive in retirement, allowing you to start budgeting early.
Defined Benefit Plans Encourage Employee Loyalty
In today’s uncertain world, it’s common for employees to hop from job to job. With a 401K, it’s easy to roll over the investments into the next 401K or IRA. While employees have to wait until they are fully vested to get the employer’s match, they are free to move their own funds as they desire. With a defined benefit plan, it’s a bit more complicated. There are more benefits of staying at the job, especially if the employee is near retirement in order to get the full benefit.
Defined Benefit Plans Encourage Employees to Work Hard
If you set your defined benefit plan up to coincide with your profit sharing, employees may be encouraged to work harder. When they can see the fruits of their labor, other than their standard paycheck, they feel more invested in the company and want to work harder to make it succeed. Your company’s success directly affects the employees’’ retirement balance, which may encourage harder workers.
Defined Contribution Plans Benefit both the Employer and the Employee
If you’re behind on your own retirement savings, you can benefit yourself and your employees by starting a defined contribution plan. With the higher limits, you can set yourself up for a successful retirement while taking care of your employees at the same time. This helps you build your business, attract more employees, and set both you and your employees up for financial success in the future.
Advantages of Defined Benefit Plans
Talk with your financial advisor about the right decision for you and your employees. A defined benefit plan has its advantages, especially if you are ‘older’ and haven’t saved for retirement yet. Your tax liability will decrease and your retirement savings will increase at much faster levels than any other retirement account allows.
- They allow for large tax deductible contributions. Contributions will generally be much larger compared to 401k plans and other defined contribution plans.
- Plans are easier to set up then you think. We have streamlined the set up process. You can have a plan established in as little as a few days.
- They can be combined with other plans. Most plans are combined with 401k plans to allow for maximum contributions. There are a few restrictions though.
- Plans can be cost effective. Plan start up costs have been lower. This is also the case with annual administration fees.
- You don’t need a financial advisor. We set up plans that can be used with many different custodians. This includes Fidelity, Vanguard and Schwab.
There are many advantages of defined benefit plans. Weigh the pros and cons of each type of plan to decide which is right for you and your employees. Look not only at the present and how it affects your bottom line, but how it affects the future of both you and your employees. You are investing not only in yourself but in the lives of your employees – the backbone of your company and the reason you have a successful company in the first place.