Defined Benefit Plan Limit: How to Maximize Your Contribution

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By now, you probably know that Defined Benefit Plans have contribution limits much higher than most other retirement structures. But how high are the limits? You might be surprised.

Your contribution depends mainly on your compensation (or income), age, and years of service. There are ways to maximize your contribution in a given year, but the lifetime limit won’t change (except for inflation adjustments).

Business owners mainly use cash balance plans to maximize their contributions and retain employees loyal and dedicated to their company. But IRS requires that a plan should meet the non-discriminatory test. A plan should not only benefit a small group of employees. So how can a business owner achieve what he wants while staying within the IRS rules?

Compensation Will Drive the Defined Benefit Limit

In addition to age limits, contributions are also limited by W2 compensation (or net income if a sole proprietor). You must have an average three-year W2 compensation of at least $230,000, or the $3.1 million will be lowered. This demonstrates why you should coordinate with your CPA and third-party administrator.

Age is a Factor in the Contribution Limit

With a Defined Benefit Plan structure, a business owner could have as much as $3.1 million at age 62. The ultimate limit will include both investment returns and contributions. As a result of annual funding requirements, the closer you are to retirement, the large your contributions. In addition, if you are younger, your contribution limit will be lower because you have a more significant time to reach retirement age.

Start Date Impacts the Contribution Limit

In the early years of the plan, the date the business began can influence the annual contribution limit. For example, a lower limit can result from a lower compensation average in the early years. In subsequent years, the compensation must be increased to achieve the highest lifetime limit. 

Years of service can have a significant impact on whether you can reach the $3.1 million limit. In fact, you may need to keep the plan open longer than intended to achieve this goal.

Adding a Spouse Can Double the Defined Benefit Plan Limit

Do you have a spouse who works in your business? Many business owners do. If the spouse is an eligible employee, the lifetime limit could double if you plan correctly. But remember that the spouse’s contribution limit will also vary depending on compensation, age, and how long they were employed. 

401(k) Plans Can Maximize the Limits

Many business owners will contribute to a 401(k) Profit Sharing Plan to increase the overall retirement limits. The business owner (and possibly the spouse) could contribute an extra $26,000 in salary deferral and receive a profit-sharing contribution of 6% of compensation. Even though the profit-sharing is limited, the higher contributions can go a long way to maximizing your retirement goals.

Consider Overfunding

Cash balance plans are based on actuarial calculations with numerous assumptions. These assumptions may allow flexibility in funding a plan, which can be overfunded in a given year. This will lead to lower funding levels in the future.

A business owner can make more significant contributions than anticipated and increase the deductions on the taxable income, therefore reducing the tax liability.

Final Thoughts

As discussed, the defined benefit plan limit of $3.1 million is a lifetime limit. There are annual funding limits that must be attained. In any case, a business owner can make much more significant contributions to a defined benefit plan compared to other retirement plans. 

Paul Sundin

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