Defined Benefit Plan Set Up Guide: 5 Retirement Start Up Tips

So, you have decided to start a defined benefit plan (also called a DB plan). But you’re not actually sure how to do it.

A business owner motivated to save on taxes and fund large contributions into retirement should consider setting up a plan. Defined benefit plans are the #1 strategy for high-income business owners.

In this guide, we show you the defined benefit plan set up process and how you can customize a plan for your small business. Let’s get started.

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How to Set Up a Defined Benefit Plan:

To set up a defined benefit plan, you can use an IRS pre-approved plan document that is issued by an actuary or administrator. You should file Form 5500 annually. In addition, Schedule SB should be signed by the actuary and attached to the Form 5500 filing.

The good news is that you can set up and fund the plan before you file your tax return. Let’s dive in!

Locate administrator or TPAAdoption agreement
Draft & customize documentBeneficiary form
Open investment accountPlan document
Coordinate plan fundingAccount application

Defined Benefit Plan Basics

Under a defined benefit plan, a participant’s account earns a pay credit, normally 5% to 8% of salary each year, plus an interest credit applied to your account balance. When the plan reaches its time to distribute the funds, one can move their funds to another tax-advantaged account in order to defer tax until when they require the distribution.

A participant under a defined benefit plan receives a benefit defined by their account balance. Let’s take an example of a participant with $100,000 in the defined benefit plan account who has attained the age of retiring, that is 65 and he retires, he is entitled an annuity based on this balance, approximately $8,500 annually for his entire life.

Contribution towards retirement is substantial especially for employees above 50 years of age. Defined benefit plan contributions can be as high as $100,000 for an employee earning a substantial income. As compared to a 401k plan, where limits are at approximately $50,000, this is, therefore, a huge boost for an accelerated retirement saving.

A tax deduction is another great advantage under a defined benefit plan. Contributions towards retirement are tax deductible for the employers. The deductions could be as high as $250,000 depending on the participant’s age and income level.

Setting Up a Defined Benefit Retirement Plan

A defined benefit plan for the self-employed is an excellent way to provide your employees with a solid retirement income. Self-employed physicians typically set up defined benefit plans to protect their incomes.

In general, eligibility is not that challenging, and you can structure a plan to benefit the owners. Employees must receive a meaningful benefit even when they are eligible.

This can equate to around 3 to 4% of their compensation. However, combining their contribution with a 401(k) profit-sharing or safe harbor plan will typically contribute 7 to 10% of total wages.

You can also include a spouse in the employer allocation. This way, a spouse can get 100% of their deemed wage into a plan while limiting the employees to just a few percent. But make sure you review these rules and requirements with your administrator. The TPA will be the one that will test eligibility on an annual basis, and the actuary is the one that will sign off on the final funding range.

The monthly benefit is usually fixed, but most plans do not include cost-of-living adjustments. Therefore, it is essential to understand the plan’s details before signing up for a defined benefit plan for the self-employed.

Step #1 – Get Financial and Tax Advisors

A key component to defined benefit planning is getting your CPA involved early in the process. Your CPA will be in the best position to understand your federal and state marginal tax bracket. Because these plans are tax deferrals, the higher your marginal tax rate, the more benefit you’ll derive from the plan.

But you must realize that many CPAs and tax professionals don’t directly understand how these plans work. They certainly have heard of defined-benefit plans, but they’re unfamiliar with how to structure them and all the compliance issues. That’s why you will need a third-party administrator.

They will collect relevant employee information like age and income levels to be used to calculate the amount to be contributed for each employee by the employer. It is not necessary to include all employees, defined benefit plans favor business owners and key employees but you should ensure that IRS non-discrimination rule is met.

Step #2 – Third Party DB Plan Administrator (TPA)

As an employer, you will have huge responsibilities with the administration of a defined benefit plan as well as plan investments. TPA will help you handle the hefty administrative tasks and let you concentrate on ensuring return on investments.

A plan administrator (or TPA) is a company that assists business owners with setting up and administering retirement plans. Managing retirement plan activities can be challenging for most employers, so it often makes sense to outsource it.

The TPA will perform many administrative functions, including many of the following:

  • Initial review and consultation of plan design and customization;
  • Discussion and analysis with CPA and financial planner regarding operational and funding aspects;
  • Drafting of all documents, including plan summary, adoption agreement, and required company consents;
  • Actuary coordination to ensure IRS & DOL compliance;
  • Structuring the plan to allow the business owner to contribute at higher levels;
  • Plan testing under ERISA to ensure compliance with ERISA; and
  • Filing form 5500 tax returns with the IRS.

Step #3 – Prepare an Illustration

Ensure that your business has standards that will ensure annual contributions are made. You should also have a requirement for a regular review on plan returns and make regular changes on the interest rate or amend or freeze a plan before it becomes a liability to the company. The plan can also be terminated at any time and plan assets distributed to the participants.

The illustration seems simple. But it will lay out various criteria you should have to make an educated decision.

This will commonly include your age, compensation, and employee census. In addition, it will typically combine a defined benefit plan contribution amount with a 401(k), deferral, and profit-sharing. You might even be giving a minimum and maximum range of funding in year one.

You may also consider overfunding or funding for prior service in year one. In essence, this allows you to take a deduction in the current year for service services performed in the past. This is an excellent option if you’re looking to maximize the year-one contribution to obtain the tax benefit.

Step #4 – Draft Plan Document

A legal document outlining all the plan details, levels of contribution and interest rates to be used is drafted and signed by the end of a tax year the company wishes to start contributing.

The plan document will also include the plan, highlights, summary, plan, description, and adoption agreement. These forms and schedules will spell out the formula required for the plan and the overall structure and design.

The IRS provides Minimum requirements, but the plan document will spell out any necessary customizations. This would include how credits are given to different groups, including employees and owners. The key is generally to maximize the owner’s contribution while minimizing employee contributions.

The goal is to get 85 to 90% of all contributions allocated to owners. This can generally be attained when you have a plan with fewer than five employees. But if you have greater than that, you might see an allocation of 80% or even lower. The goal is to have a disparity between the owner and the employees concerning age and W-2 compensation.

When the plan is established, you will receive the following plan documents:

  • Adoption Agreement
  • Legal Plan Document
  • Summary Plan Description or “SPD”
  • Retirement Plan EIN
  • Beneficiary Designation Form
  • IRS Opinion Letter
  • Consent of Action
  • Participant Highlights

Step #5 – Make Contribution

Ensure that your contributions are made by tax return due date. An extension can be obtained, but contributions should not go beyond eight and a half months after the year ends.

A defined benefit plan is the best pension plan for your company. It not only offers significant savings towards employee retirement, but it also offers a substantial tax deduction for the company.

Defined Benefit Plan Third-Party Administrator (TPA)

A third-party administrator (TPA) offers services to other companies on insurance or pension plans. Managing all plan activities may be hard for employers; therefore, they contract a third-party administrator to handle much of the hefty administrative work to concentrate on the remaining investment work. The Society of Professional Benefits Administrators (SPBA) claims that TPAs manage about 66% of pension plans.

Choosing a TPA is like getting married. You will need to form a close relationship to entrust them to manage your assets. Having a good relationship in the future depends on how much you know about the TPA and how confident you are before walking down the aisle.

Choosing an administrator should not end when you sign an engagement letter with them. Make sure you take time, undertake continuous evaluation, and compare what they promised to accomplish and their results. There are aspects to be considered apart from the ones listed. TPAs play a crucial role in the performance of the benefit plan.

Do I Have to Have an Administrator?

A cash balance plan is a defined benefit pension plan that an employer sponsors. The employer is responsible for setting up and managing the cash balance plan.

However, it is common for employers to delegate certain tasks associated with the cash balance plan to a third-party administrator (TPA). A TPA is a company that provides administrative and support services to employers and employees who participate in a cash balance plan. The TPA is responsible for calculating and maintaining employee account balances, communicating with employees, processing employee transactions, providing customer service, and ensuring compliance with regulations.

How do You Create a Defined Benefit Plan?

In addition to TPAs, employers may also work with other professionals to set up and manage a cash balance plan, such as attorneys and financial advisors. These professionals can provide guidance on legal and regulatory requirements, assist with the development of the plan document, and provide advice on investment options.

The employer is responsible for setting up and managing a cash balance plan. Still, they may delegate certain tasks to TPAs and other professionals to ensure the plan is administered effectively.

The Combo Plan

One significant benefit to defined benefit plans is combining them with 401(k) plans to increase the overall tax benefit. In fact, most clients will combine a defined benefit plan with a 401(k). This allows them to get the employee deferral and the profit-sharing contribution. A contribution for the profit sharing is limited to 6% of the employee’s deemed wage. This is contrary to the typical 25% contribution for a W-2 or 20% for a sole proprietor filing on IRS Form Schedule C.

Unfortunately, you do lose a little bit on the profit-sharing side. But you make up for it substantially with a defined benefit plan.

In addition, you will receive a funding range that will include minimum and maximum amounts. But the critical number you want to pay attention to is the target amount. This amount will keep your plan in line to give you a straight-line contribution.

But if you can maintain a targeted contribution, this should widen your funding range in future years. This will enable you to get a significant, tax-deductible contribution in years with higher income and then reduce it in weaker years.

How to Set Up a Defined Benefit Plan

5 Steps to setting up a defined benefit plan:

  1. Contact a third-party administrator (TPA)

    A TPA will show you the many options you have and complete any necessary documents. Make sure you inquire about the fee schedule and the annual administration process. Many TPAs don’t have a lot of experience with defined benefit plans, so choose an administrator with experience in the marketplace.

  2. Run a few illustrations

    Your TPA can run some illustrations with different plan options. They will typically show minimum and maximum contributions along with expected tax savings. Most illustrations will also combine the plan with a 401k so you can see the total contribution levels and any combo restrictions.

  3. Customize the plan structure

    You can front-load a plan to give you high funding levels in year one in most situations. You can also consider prior-year service contributions that can be amortized over seven years. This can allow more contributions in the first several years. You have options to tailor the plan to your business, so make sure you plan accordingly.

  4. Finalize the plan documents

    Once the plan is customized, plan documents need to be drafted and signed. There are employee reporting requirements, and necessary details must be shared. The investment account must be set up, and this alone can take a couple of weeks, so plan accordingly.

  5. Fund the plan

    This is usually the easiest part, but it can often be overlooked. Don’t miss the deadline. The plan needs to be funded before filing the tax return for the prior year (with the latest date being Sept 15th). The contributed amount need to be communicated to your CPA.

Take a look at the table below. It breaks out the steps in the process and the documents to be signed.

Locate administrator or TPAAdoption agreement
Draft & customize documentBeneficiary form
Open investment accountPlan document
Coordinate plan fundingAccount application

Final Thoughts

We know that defined benefit plans can be complicated. That’s why we wrote this defined benefit plan set up guide.

Constant cash flow is however required to ensure minimum frequent plan alterations which may prompt IRS to classify a plan as a deferral arrangement rather than a pension plan. A defined benefit plan also allows for the addition of a 401k and profit sharing plans for even higher contributions.

Paul Sundin

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6 thoughts on “Defined Benefit Plan Set Up Guide: 5 Retirement Start Up Tips”

  1. My accountant says I need to get one of these plans set up. How long does it take for you guys to set up a plan from start to finish?

    • We can have a plan set up in as little as two days. We typically want to have a planning call so we can discuss what you are trying to accomplish. Then you will complete our new plan checklist which basically contains information about your business (name, EIN, etc) and then we can finalize all the plan documents. Like I said we can do it in a couple days if you need something expedited.

    • Hi Esan – The cost depends on the plan structure. But as a general rule, if it is a solo plan it will cost $1,240 to set up. The annual administration is $1,950. Just use our contact page to get in touch with us if you are interested.

  2. My company is on a fiscal year. My wife and I are the only employees. If we take w-2’s this year and next year with both w-2’s occurring during the fiscal year can we fund a defined plan for 2021 w-2’s and also for 2022 w-2’s?
    We incorporated 08/21 and have been very profitable from day one.

    • Hi Leonard – it sounds like you are looking to maximize the 2021 contribution? Also, since you are a C-corp, your goal is probably to zero out your tax return. I would take a contribution that is close to your maximum allowable. Your plan would be overfunded after year one and it would reduce future contributions, but it would allow you a max deduction up front. This can be a great structure in high income years. Reach out to us and we can run an illustration for you.


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