Floor Offset Defined Benefit Plan: Tips & Strategies


In order to have a floor offset arrangement, both a defined benefit and a defined contribution plan must be in place. The term floor offset describes the relationship between the defined benefit and the defined contribution
plan.

How the Benefit in the Defined Benefit Plan is Calculated

An equivalent normal retirement benefit that could be provided by the account balance in the defined contribution plan is calculated using the definition of actuarial equivalence in the defined benefit plan. This requires a projection of the account to the normal retirement date, and the method of projection must be specified in the defined benefit plan document.

Floor-offset plans are subject to a uniformity requirement. A level percentage of compensation must be used to offset the defined benefit plan benefits for all participants, even if the employer provided benefit in the defined contribution plan is not allocated uniformly.

self employed

If the equivalent benefit determined from the defined contribution plan exceeds the accrued normal retirement benefit from the defined benefit plan, the participant will receive benefits exclusively from the defined contribution plan.

In other words, the participant’s net benefit in the defined benefit plan would be $0. Even when the change in a participant’s net benefit over the course of a plan year is zero or negative, that participant is still considered to be benefitting under 401(a)(26).

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If the equivalent benefit from the defined contribution plan does not exceed the accrued benefit from the defined benefit plan, then the total benefit that the participant will receive from both plans will be equivalent to the full pension benefit under the defined benefit plan’s formula.

The participant will receive the account balance from the defined contribution plan, plus the net accrued benefit (defined benefit accrued benefit less the defined contribution equivalent benefit) from the defined benefit plan. Elective deferrals under a 401(k) plan cannot be used to offset a participant’s benefit under a defined benefit plan.

The defined benefit plan can use either a flat benefit or unit benefit formula. It can also use permitted disparity for the tax return.

Floor Offset Example

  • Defined benefit plan participant’s gross accrued benefit before offset: $300/month
  • Defined contribution plan participant’s equivalent benefit: $200/month
  • Defined benefit floor offset participant’s net benefit = $300 – $200 = $100/month

The overall result is that the participant is entitled to the defined contribution account balance and a floor offset benefit of $100/month from the defined benefit plan.

defined benefit plan rules

Note that the participant does not receive the equivalent benefit of $200/month instead of the defined contribution account balance. This $200/month is just used in the determination of the floor offset amount from the defined benefit plan.

Another Floor Offset Example

  • Defined benefit plan participant’s gross accrued benefit before offset: $200/month
  • Defined contribution plan participant’s equivalent benefit: $300/month
  • Defined benefit floor offset participant’s net benefit = zero

The overall result is that the participant is entitled to only the defined contribution account balance.

Reasons an Employer Might Consider a Floor Offset Arrangement

  • Participants seem to better understand and appreciate a defined contribution plan.
  • Younger employees can see a definite build-up of plan assets in the defined contribution plan.
  • The effects of compound interest mean younger employees achieve higher retirement income levels in a defined contribution plan. The defined benefit plan allows employees hired later in life to accumulate higher levels of retirement benefits far more rapidly than would be allowed in a defined contribution plan. As a result, both younger and older employees can derive higher benefits than from a single defined benefit or defined contribution plan.
  • The defined contribution plan could be a profit sharing plan, thus providing considerable contribution flexibility.
  • Employees who continue in service until retirement age are assured of a minimum retirement income equal to that provided by the defined benefit plan. There is no such assurance when the only plan is a defined contribution plan.
  • If the employer’s intent is to phase out a defined benefit plan in favor of a new defined contribution plan, a floor offset arrangement can maintain the expected defined benefit for participants near retirement while younger workers will gradually build up defined contribution balances large enough to allow the eventual termination of the defined benefit plan with no decrease in benefit levels from those offered by the traditional defined benefit plan.
Paul Sundin

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