How to Set Up a Defined Benefit Plan: 5 Start Up Tips [+ Pitfalls]

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So you have decided to start a defined benefit plan (also called a DB plan). But what is the process? In this post, we show you how to set up a defined benefit plan.

A business owner with an ambition to save more towards retirement as well as save on federal taxes will consider a defined benefit plan. Defined benefit plan works best for business owners and key employees with high-income levels.

In this guide, we will show you how to start a plan and detail some tips and tricks. The good news is that you can set up and fund the plan before you file your tax return. Let’s dive in!

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.

Defined Benefit Plan Background

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.

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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.

Step #1 – Get financial and tax advisors

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.

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.

setting up a defined benefit plan

Step #4 – Draft plan document

A legal document outlining all the db 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.

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.

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

Starting a defined benefit plan

We know that defined benefit plans can be complicated. That’s why we wrote this “how to set up a defined benefit plan” 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 “How to Set Up a Defined Benefit Plan: 5 Start Up Tips [+ Pitfalls]”

  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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