Defined benefit plans have tax advantages, but who manages them?
Many parties play distinct roles in managing a defined benefit plan. Over 90% of financial advisors lack deep expertise in these plans, making alignment among actuaries, TPAs, and advisors essential.
This article explains who oversees plan administration and their key responsibilities.
Who is able to set up and manage a defined benefit plan?
The company or a chosen financial advisor manages investments, while the employer bears investment and funding risks. Financial advisors may guide investments, but employers remain accountable. Changes in investment value don’t affect promised benefits, as actuaries and TPAs ensure funding levels and compliance.
Administration Background
Defined benefit plans blend aspects of traditional pensions and 401(k)s. A team of qualified, experienced professionals should manage these plans to ensure compliance and provide the expected benefits.
The plan sponsor, typically the employer, is ultimately responsible for the plan. They work with a plan administrator, often a TPA, to design and implement compliant plans.
The plan administrator manages daily operations, including contributions, benefits calculations, recordkeeping, and ensuring regulatory compliance.
Plan administrators often communicate plan features and benefits to employees and are usually independent TPAs with the necessary expertise.
Defined Benefit Plan Administrator (TPA)
A defined benefit plan administrator oversees operations and ensures promised retirement benefits are delivered to employees.
Such plans use a formula based on years of service and pay, often appealing to small business owners and the self-employed.
The administrator manages plan design, contributions, calculations, and recordkeeping. They ensure compliance, file required reports, and update plan funding or benefits as required by regulations.
Administrators advise on plan design, funding, and compliance. Although some administrators may offer investment guidance, the sponsor or trustee is primarily responsible for investment decisions, while actuaries project funding requirements and calculate benefits.
Who Manages a Defined Benefit Plan?
A defined benefit plan administrator manages a retirement plan that provides employees with a fixed benefit at retirement.
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As a cash balance plan administrator, some of the essential duties and responsibilities may include:
- The administrator designs the plan to meet legal standards and employee needs.
- The administrator educates employees on plan rules, eligibility, contributions, and benefits.
- Administrators ensure contributions comply with the rules and adjust funding. Avoid overfunding to prevent extra taxes.
- The administrator calculates employee benefits based on service and salary.
- The administrator keeps records and provides required reports to participants and agencies.
- The administrator tracks law changes and ensures ongoing compliance.
Plan administrators help employees prepare for retirement by managing plan finances and benefits accurately.
How to Manage a Defined Benefit Plan
Here are 5 ways to manage a plan:
- Regularly review plan performance
- Regular reviews help ensure the plan aligns with company goals. Involve your CPA and advisor.
- Monitor funding requirements
- Monitor plan balances and contributions to ensure funding needs are met. Overfunding can lead to large taxes.
- Manage investment risks
- Diversify investments, use experts, and keep allocations conservative.
- Stay compliant with regulations
- Keep current with regulations and file forms on time.
- Communicate effectively with plan participants
- Notify employees of benefits and plan changes. Send statements immediately.
Plan Investments
Defined benefit plan investments are typically managed by the plan sponsor or an investment advisor, not by employees. The goal is to earn returns that help fund promised benefits over time.
Because benefits are defined by formula, investment risk falls mainly on the employer. That reality shapes the portfolio’s asset allocation and risk tolerance.
Most defined benefit plans emphasize diversification across stocks, bonds, and sometimes alternative assets. Many plans tilt heavily toward fixed income to match long-term liabilities.
Some use liability-driven investing strategies, aligning bond maturities and interest rate exposure with projected benefit payments. The objective is to reduce volatility in funded status and contribution requirements.
Is a Cash Balance or Defined Benefit Plan Right For You?
Investment strategy also considers funding rules, contribution budgets, and the sponsor’s overall risk profile. A more conservative employer might favor lower volatility and higher bond allocations.
Others may accept more equity exposure to potentially lower long-term funding costs. Regular reviews with an investment advisor and actuary help keep the portfolio aligned with plan obligations.
Does a Defined Benefit Plan Require an Actuary?
A defined benefit plan generally does require an actuary, especially once it becomes ongoing and funded. The core promise of the plan is a specific retirement benefit formula, not just a contribution amount.
To support that promise, the IRS and Department of Labor rely on actuarial calculations. An enrolled actuary certifies funding requirements, minimum contributions, and compliance with applicable rules.
In most cases, the actuary prepares annual valuation reports for the plan sponsor. These reports calculate the plan’s funded status, required and maximum deductible contributions, and projected liabilities.
The actuary also considers assumptions like interest rates, mortality, retirement ages, and employee turnover. Small changes in these assumptions can significantly impact contribution levels and funding percentages.
There are limited situations where a defined benefit plan may operate briefly without ongoing actuarial services, such as during initial plan design discussions. However, once the plan is active and contributions are being made, actuarial involvement becomes essential.
Without an actuary, the sponsor risks underfunding, compliance failures, or incorrect deductions. For most business owners, hiring a qualified actuary is simply part of responsibly running a defined benefit plan.
Final Thoughts
Retirement planning offers many solutions, especially for owners with few employees, typically involving a 401(k) with profit sharing and a defined benefit plan.
Most of my clients can quickly understand the mechanics of a 401(k) plan. But a defined benefit plan is entirely different.
Overall, qualified retirement plans are an essential tool for helping employees save for retirement and should be carefully considered by both the company and employees as part of their overall retirement savings strategy.
