Defined benefit plans offer significant advantages to the self-employed. But how much does a defined benefit plan cost and what are the fees?
Defined benefit plan rules require higher administrative requirements as compared to other plans. Before choosing a defined benefit plan, it is advisable that you analyze the plan costs to determine if it will be economical. In this post, we take a close look at provider fees.
Table of contents
What is a plan and how does it work?
A defined benefit plan is a type of retirement structure that provides a predetermined benefit to employees upon retirement, based on factors such as the employee’s salary and years of service. Defined benefit plans are also known as pension plans, as they are designed to provide a steady stream of income to employees during their retirement years.
| Fee Structure | Reporting |
| Plan Set Up = $1,200 to $2,000 | Schedule SB |
| Annual Administration = $2,000 to $4,000 | Plan Illustration |
| Participant Fees = $150 | Actuarial Valuation |
| Loans, RMDs & Consulting | IRS Form 5500 |
In a defined benefit plan, the company assumes the responsibility for funding the plan and for paying the retirement benefits to employees. The employer’s contributions to the plan are based on a predetermined formula, which may take into account factors such as the employee’s salary and years of service. The employer may also hire a third-party administrator (TPA) to manage the plan and ensure that it is in IRS compliance with all applicable laws and regulations.
Defined benefit plans offer many benefits to employees, including a guaranteed retirement benefit that can provide financial security in the employee’s retirement years, as well as tax benefits for both employer contributions and employee contributions. Defined benefit plans may also be attractive to employers, as they can help to attract and retain top talent and foster a sense of loyalty among employees.
However, defined benefit plans also have some drawbacks, including the potential for higher costs for the employer and the fact that they may be less flexible than other types of retirement plans, such as defined contribution plans. It is important for employers and employees to carefully review the features and requirements of a defined benefit plan and to consult with a qualified professional to determine whether it is the right fit for their needs.
Some background
Participants not only enjoy large contributions, but sizable tax deductions. Defined benefit plan providers will charge costs and fees according to their duties. The provider should offer the following services:
- An upfront plan consultation with design options.
- Discuss the plan with the CPA or tax professional as well as the financial advisor.
- Draft the custom plan documents with actuarial review.
- Ensure that contributions are made by the plan deadline.
- Provide actuarial review and form filings.
- Monitor annual plan compliance.
- Terminate a plan (as necessary) based on changing circumstances or business conditions; and
- File all required tax returns with the IRS and Department of Labor.
How much does a defined benefit plan cost?
Services sometimes may be similar among providers, but plan costs and fees have wide variations. Some may charge as low as $1,500 and others as high as $15,000.
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Defined benefit plans with just one employee can attract low charges. As more and more employees are added, the plan gets more complex with costs going up due to several reasons like testing requirements.
On average, a defined benefit plan should cost around $1,500 to $2,500 to set up. Other costs include administration and tax filing fees which can be around the same amount. But the defined benefit plan cost can vary depending on employee count and plan design.
Defined Benefit Plan Low-Cost Providers
Business owners can certainly consult low-cost providers. However, low-cost providers may not offer advice on plan design. A company wishing to set up a plan must do an extensive consultation with a defined benefit plan TPA and review several illustrations to ensure the plan will work right for their company.
Having a defined benefit plan will subject an employer to higher fees as compared to other plans like a 401k plan. But this can be justified by high contributions and the need for annual actuarial reviews.
These fees are however tax deductible. Those on a high tax bracket, which is the case for defined benefit plan participants may only pay 60% on the dollar for those fees on an after-tax basis. Considering the return on investment, defined benefit plans have reasonable pricing schedules in general.
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Set up for 2022 or 2023
Spending $5,000 in the plan set up is a bit high unless it is a very complex plan which requires substantial upfront consulting. Our plans range between $2,000 and $3,000 for setting up and comparable fee schedule for annual compliance and review.
Unless you need a complex advice, you should ensure that your provider classifies you on the low-end of the rate schedule when setting up a plan. However, do a due diligence before concluding that you need a low-fee provider, the cost is just one significant factor but other factors should also be considered.
Sometimes, low cost providers do not make sense, you always get what you pay for. Going for a low cost provider may make more sense for solo defined benefit plans. But it may not be customized to fit your business. Look for a provider who will ensure your plan achieves set goals.
What is a Defined Benefit Plan?
A defined benefit plan is a retirement program that promises a specific benefit to participants at retirement age. The benefit is normally defined as a monthly pension equal to a percent of pay (flat benefit plan) or a percent of pay times years of service (unit benefit plan). The compensation used in calculating the monthly benefit is usually based on the highest three or five year average.
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In a defined benefit plan, the plan sponsor contributes whatever is necessary to reach the promised payout at retirement age. An actuary converts the monthly annuity payable at retirement to a lump sum. The actuary then determines each year what amount is required as a contribution based on the current value of plan assets and the date those benefits are due to each participant.
The contribution can vary depending on investment returns. Low investment returns cause higher required contributions, and high investment returns lower the contribution requirement.
| Issue | Fee or Cost |
|---|---|
| Draft plan document | $990 |
| 1st participant | $250 |
| Past service adjustment | $100 |
| Consultation & review | free |
| Form 5500-EZ | free |
| TOTAL FEE | $1,340 |
How to determine the cost of a defined benefit plan
Here are the 5 steps to determining the plan administration fees:
- Determine plan customizations
Some plan tailoring is easy, but some can be complex depending on the plan structure. You can choose a flat dollar contribution for year one or even variable based on compensation. You also have the ability to determine the interest crediting rate. It can be fixed, variable or even a market rate. The decisions should not be taken lightly.
- Examine employee census
How many employees does the company have? Solo plans are relatively easy to administer. But the more employees the company has the more testing that is required. The illustration should have at least 80% going to the owner to make economic sense.
- How close are you to the deadline?
As we approach the end of the year, most TPAs will have limited price flexibility. But outside of busy season, there can be new client discounts. We know of many administrators that have a cut-off deadline. This is usually mid-summer, before the extension deadline rush.
- Do you need require prior or past service?
Opening balance credits for prior service can be a little more challenging. As such, plan costs can increase. Remember that year one is the only year that you can get an opening plan credit. This makes sense if you have higher income in the year. However, if you expect your income to increase in the coming years, then you may want to save the funding flexibility for future years.
- Coordinate with CPA and financial advisor
Multiple conference calls and completing plan structuring with many parties can take time and add to the cost. Surprisingly, many CPAs and advisors don’t know much about these plans. You should communicate with all parties as soon as possible in order to eliminate errors.
Bottom line
So if you are asking the question – how much does a defined benefit plan cost? The answer is…it depends. Services can vary substantially. But make sure that you do your own due diligence and find a third party administrator that can work within your budget.
