Owner-Only Defined Benefit Plan: Quick Set Up Guide [Video]


Defined benefit plans are associated with large companies. But is there such a thing as a owner-only defined benefit plan?

In this post, we will discuss owner-only plans and show you the steps to get one set up. So let’s get going.

Is There Such Thing as an Owner-Only Defined Benefit Plan?

Defined benefit plans can be set up as owner-only plans. In fact, probably over half of our plans are what you would call “solo” plans.

How do the plans work? Generally, a defined benefit plan attempts to specify benefit levels for employees. Once benefit levels are established, contributions are determined based on actuarial calculations. The employer assumes the investment risk used by the employee benefit trust that administers the plan’s assets.

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If the investment returns cause the plan assets to fall below the amount actuarially necessary to pay the defined benefits, then the employer must make additional contributions. Thus, defined benefit plans are subject to the minimum funding requirements under ERISA, whereas those rules have little meaning for defined contribution plans.

Owner-Only Retirement Plans

In such a plan, income over the forecast levels benefits the employer by reducing future contributions (§412(b)(3)). Although contributions may vary based on the investment program, such plans are a fixed obligation of the corporation, and contributions must be made annually to the plan regardless of the company’s profits.

The primary form of the defined benefit plan is the defined benefit pension plan. A defined benefit pension plan must provide the payment of definitely determinable benefits to the employees over the years after retirement. In short, it guarantees a monthly income for a participant at retirement age.

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Benefits are measured by years of service with the employer, years of participation in the plan, percent of average compensation, or a combination thereof. In addition, most defined benefit pension plans pay Pension Benefit Guaranty Corporation premiums to ensure that participants’ guaranteed benefits will always be paid at retirement.

Special Rules for Owner-Only Plans

Plan design is a process by which the plan sponsor ensures that the retirement plan will meet the business’ goals and objectives for retirement savings, employee retention and tax efficiency.

For example, for a company whose critical employees (i.e., owners, officers, key management, etc.) are older than the majority of the employees, a defined benefit plan may make the most sense because it is possible for the critical employees to accumulate a much larger benefit over a shorter period of time than could ever be accomplished in a defined contribution plan.

A defined contribution plan is limited in the amount of contribution a plan sponsor can allocate to each employee. Due to this contribution limitation and the age of the employees, there may not be sufficient time to accumulate the desired retirement benefit using a defined contribution plan.

Since benefits are limited in a defined benefit plan but contributions are not, and the amount contributed is determined actuarially to accumulate to the desired benefit, a defined benefit plan allows for accumulation of sufficient funds for retirement in a short period of time. This is especially true for older participants.

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In plan design, the type of formula considered should be based on how the plan sponsor wishes to benefit certain groups of individuals. If it is important to the plan sponsor to favor employees with long service, then a unit benefit plan may be best. If the plan sponsor wishes to favor employees based on compensation level, then the formula should use a percentage of pay instead of a flat dollar amount.

The plan sponsor should also consider the amount of money it can afford to contribute to a plan each year. A high dollar amount or percentage of pay formula may require a greater contribution than the plan sponsor can afford. Thus, the plan formula should be designed with a budget in mind. The IRS requires that a plan be “permanent” and not just a temporary tax structure.

Although plans can be terminated for valid business necessity, the sponsor should plan on maintaining a plan for many years since the IRS expects plans to satisfy a “permanency” standard. This standard usually includes a minimum number of years that the plan is in effect. Although not officially defined, the minimum years often is cited as three to five years.

How to Set Up an Owner-Only Defined Benefit Plan

AdvantagesDisadvantages
Contributions as high as $300kIRS Permanency Requirement
Self-Directed InvestmentsMandatory Contributions
Flexible Plan DesignHigh Set Up & Administration Fees
Generous Funding RangeConservative Investment Mix
Paul Sundin

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