Defined benefit plans come with a complex design, a big concern for many business owners. But do you know who is eligible for the defined benefit plan?
Most people are OK with contributing a specified amount to their employees. They don’t want to be stuck with a contribution they can’t afford.
For this reason, eligibility can make or break a defined benefit plan. The rules specify minimum standards that each company must meet.
In this article, we discuss the eligibility rules and explain a few critical provisions you can use for your benefit. Let’s jump in!
Background
Defined benefit plans are retirement plans that provide a specified benefit to eligible employees upon retirement, usually based on a formula that considers factors such as years of service and earnings history.
Eligibility for defined benefit plans varies by plan, but generally, an employee must meet certain requirements to become eligible to participate. These requirements may include factors such as:
- Age: The plan may specify a minimum age for participation, such as 21 or 25 years old.
- Service requirement: The plan may require a minimum number of years of service with the employer, such as five or ten years before an employee is eligible to participate.
- Employment status: The plan may require the employee to be a full-time or regular employee to participate.
- Earnings threshold: The plan may require the employee to earn a certain amount of money to participate.
Once employees meet the eligibility requirements, they participate in the plan and can begin accruing benefits based on the plan formula. The plan sponsor is responsible for funding and managing the investments, and the employee is generally not required to contribute to the plan.
It’s important to note that defined benefit plans have become less common in recent years, with many employers opting for defined contribution plans such as 401(k)s instead.
Specific eligibility rules and requirements
A computation period is a time of 12 consecutive months that is selected by the company and defined in the plan. The plan must specify a period for measuring service years for eligibility, benefit accruals, and vesting.
A participation year (or credited service) could be any consistent 12 consecutive month period specified in the plan document. Under Department of Labor (DOL) rules and regulations, a plan can consider any 12-month period during which the employee has worked less than 1,000 hours.
Because of this rule, a plan typically requires the employee to complete at least 1,000 hours of service to qualify for a year of credited service under the plan. However, the plan could be more liberal and allow less than 1,000 hours for a given year of credited service.
| Plan Advantages | Plan Disadvantages |
|---|---|
| Tax-Deferred Investments | Complex Structure |
| Rollover to IRA at Termination | Mandatory Funding Level |
| Flexible Range | Permanent Plan Design |
| Tax-Deductible Contributions | High-Cost Structure |
Other alternatives are available, and defined benefit plans offer great flexibility to business owners. For example, seasonal industries, can require a lower number of service hours. The plan could require more than 1,000 hours worked for a year of benefit accrual (typically 2,000 hours) as long as prorated accruals are credited for employees with fewer than the required hours but more than 1,000 hours. This proration can only be made in certain plans with specific benefit formulas.
Any retirement benefits accrued in a defined benefit plan are subject to income tax when the money is withdrawn. This means that maximizing the income tax benefits of a defined benefit plan requires thorough analysis of your future tax position.
What are the defined benefit plan deadlines?
Defined benefit plan deadlines can vary depending on the type of deadline and the plan’s specific provisions. Here are some critical defined benefit plan deadlines to keep in mind:
- Plan adoption deadline: This is the deadline for employers to adopt a defined benefit plan for the plan year. The deadline is usually December 31st of the plan year, although exceptions may apply.
- Plan amendment deadline: This is the deadline for employers to amend the plan. The deadline is generally the last day of the plan year, although some amendments may be allowed to be made retroactively.
- Employee eligibility deadline: This is the deadline for employees to become eligible to participate in the plan. The deadline can vary depending on the plan’s provisions, but it is usually based on age, years of service, and employment status.
- Vesting deadline: This is the deadline for employees to become vested in their plan benefits. Vesting schedules can vary, but the deadline is usually based on a certain number of years of service with the employer.
- Funding deadline: This is the deadline for employers to contribute funds to the plan. The deadline is usually based on the employer’s tax year, and contributions must be made by the due date of the company’s tax return.
Plan sponsors must be aware of these deadlines to ensure compliance with the plan’s provisions and avoid penalties and fines. Plan sponsors may want to consult with a qualified retirement plan specialist or benefits consultant to ensure they meet all applicable deadlines.
Vesting requirements
Recent IRS tax changes have clarified the vesting rules for defined benefit plans. Typically, defined benefit plans have more restrictive vesting schedules than many other qualified retirement plans. However, the company can favorably structure vesting schedules.
All plan employee must be 100% vested upon three years of participation. As such, most plans are established using a three-year vesting schedule.
This means participants are vested in plan contributions once they reach their third year of employer service. At this date, they become 100% vested. Should any employee become terminated before the third year of plan service, all contributions are forfeited and can be used to lower future contributions.
Final thoughts
A defined benefit plan can co-exist with your 401(k) plan or be a standalone plan. Understanding the maximum payout amounts and who is eligible for a cash balance plan is essential.
Defined benefit plans allow employees to build large retirement accounts. Because they are company-sponsored, they are available to almost business type.
