Defined Benefit Plan Basics

Frequently Asked Questions about Defined Benefit Plans


Annual Contributions

Is my contribution mandatory?


·  Yes. A contribution is required each year to fund the benefit promised at retirement. This is called the ‘minimum contribution requirement’ (MCR) . However, the plan benefit formula can be amended for future years and thus increase or decrease the contribution amount. Also, aggressive funding of your plan in the first two or three years may allow you to ‘skip’ one or more years’ contributions while still satisfying the MCR, and without making other changes to your plan.


·  Is my annual contribution limited to a percentage of income like a SEP or Profit Sharing plan?

No. Your annual contribution is determined as a function of age, compensation, investment performance, actuarial assumptions and maximum benefit allowed. An actuary calculates the amount that you must fund each year.


·  When is my annual contribution due?

The deadline for pension plan contributions is no later than 8 1/2 months after the close of the plan year. For the contribution to be deductible, you must make it on or before the due date of your tax return (with extensions).


·  Can my contribution amount be reduced after I set up my plan?

Yes. This can happen in several ways. You can always amend your plan formula down for future years (but, depending on when you amend the plan, you may still be required to make the contribution for the current year). If your compensation decreases, your annual required contribution may decrease. If your investment performance is greater than the assumed interest rate, your contributions will also decrease.


·  What is the maximum amount I can contribute?

The maximum that you can contribute each year is determined by the amount required to fund your maximum allowable annual benefit on your retirement date. The maximum annual benefit is 100% of your highest three-year average compensation, up to a certain dollar maximum. Your contribution is determined by an actuary and is not limited to a maximum dollar amount.


·  How do I know how much money must be contributed each year to the my Defined Benefit plan?

Sheffler Consulting Actuaries, Inc. will inform you annually of contribution requirements for the coming year. At the end of the year, Sheffler Consulting Actuaries again will remind you to fully fund the contribution before filing your taxes.


·  What factors determine how much I can contribute in subsequent years?

Actual investment earnings vs. the assumed interest rate

Changes in compensation

Changes in the maximum benefit limits

These are inter-dependent. For example, if assets earn more than the assumed rate (decreases the contribution) and compensation increases (increases the contribution), we may get the same contribution amount as the previous year.


·  What money can I use for contributions?

Contributions must be made by the business that is sponsoring the plan. A sole-proprietor may have more than one source of money, but in no event can a sole-proprietor deduct more than the net income generated from the business that is sponsoring the plan. This deduction limitation does not apply to plans sponsored by corporations.



·  What happens if my investment performance is greater than the actuarial assumed interest rate?

If the investments grow faster than expected you will be required to put less money into the plan to achieve your goal.


·  Is there a ceiling (or a floor) on how much my investments can earn?

Your plan places no restrictions on investment volatility. You and your investment advisor are responsible for selecting and managing your investments. If your investments earn above the assumed rate of return, your required contributions will decrease. If they earn below the assumed interest rate, your required contributions will increase.


·  Can I invest in real estate?

These type investments require substantial additional care. There are special regulations that must be satisfied in order for a real estate investment to be acceptable in a qualified retirement plan. There is a separate FAQ on this subject. In general, only publicly traded REITs are exempt from these rules. If you intend to invest some of your retirement fund assets in real estate, we recommend that you do so only with the advice of legal counsel specializing in ERISA plans.



·  When can I retire?

You can stop the plan at any age and roll the value of your benefit over to an IRA. Routinely, however, a plan is expected to be maintained at least five years and the earliest retirement date is age 55.


·  What happens if I quit working before my plan's retirement date?

That's fine. Your plan can be terminated at any time and the value of your benefit rolled over to an IRA. Early planning is always helpful, so inform us as early as possible if you intend to stop working before the plan's retirement date.


·  Do I have to retire on the plan's specified retirement date (year)?

No. The plan's retirement date is one of the provisions used to determine the amount of money you must contribute each year. You may be able to amend your plan to change the retirement date. Let us know as soon as possible so we can make the appropriate amendments.


·  How do I terminate my plan?

You submit final filings to the IRS and the actuary calculates your benefit under the plan. Depending on how much money you have accumulated, you may have an excess or a shortfall to fund before your plan is terminated.


·  How do I take money out of my plan at retirement?

You can choose from several options once you decide to start taking the money out of the plan. One is to terminate the plan, and roll your money into an Individual Retirement Account (IRA). Another is to purchase an annuity, and start receiving regular distributions. Income taxes must be paid when distributions are received.




·  I have employees other than myself. Do I have to cover them in the Defined benefit plan?

All eligible employees must be included. Selecting a one-year/1000 hours entry requirement will prevent any part-time employees from entering the plan.


·  I own more than one business. Do I have to cover employees in both businesses?

Generally, yes. If you own other businesses and you are considered part of a controlled group or affiliated service group, then all businesses must be covered under the plan.


·  I already participate in a plan sponsored by another company where I am employed. Can I participate in both plans?

You can participate in both plans if the two companies are not part of a controlled group - that is, two or more firms controlled by the same 5 or fewer people.


·  In the past, I have had a Profit Sharing Plan for my business. Can I now terminate that plan and set up a Defined Benefit Pension Plan?

Yes. Your existing profit sharing plan can be terminated and you can set up a defined benefit plan. However, if you have already made your profit sharing contributions for the current plan year, those contributions might not be deductible if the defined benefit plan is established for the same year. In any year in which an employer maintains a defined benefit plan and a defined contribution plan, the maximum deductible limit for both plans is the GREATER OF (1) 25% of total compensation, or (2) the amount necessary to fund the defined benefit plan. Usually, the contribution amount for the defined benefit plan exceeds 25% of total compensation, so any employer contribution to the defined contribution plan might not be deductible this year. Please talk to your tax advisor and refer to IRS Publication 560 concerning deductibility and carryovers to future years.


·  Can I maintain both a 401(k) plan and a Defined benefit plan?

Yes. Elective deferral contributions do not count against the deductible limit described above. As long as the 401(k) plan is a deferrals only plan, you can make contributions to both plans. Employer contributions to a 401(k) plan over 6% of pay will severely limit your defined benefit plan contributions and deductions, as noted above. An employer can contribute up to 6% of pay to a profit sharing or 401(k) plan without reducing the deductible limits in their company's defined benefit plan.


More Questions

·  What is a defined benefit plan?

A defined benefit plan is a qualified plan in which you set a target retirement benefit - the amount you want to have when you retire; then your annual contributions are calculated to provide that benefit. Contributions are based on current age, the average of your three highest years of income, your planned retirement age, and in subsequent years, the balances you have accumulated in the plan. Annual contributions are mandatory and a higher benefit will result in higher annual contributions. Contributions will increase or decrease as the four factors mentioned above change.


·  Can a defined benefit plan be amended?

Yes. Generally, you can amend the plan to increase the benefit formula or decrease the formula. You cannot amend up, then amend down, then amend up, then amend down, etc., since this may be viewed by the IRS as abusive.

Following are some of the changes that can be made:

Change your benefit formula. You can decrease or, if you qualify increase your benefit formula, thereby changing your contribution amount.

Change your retirement date or age at retirement, if you qualify.


·  Are loans or hardship withdrawals allowed?

The plan does not permit hardship withdrawals. Participant loans are available if the employer chooses this feature.


·  What laws changed to make defined benefit plans more attractive for small business owners?

§Section 415(e) of the Tax Code was repealed. Because of the repeal, a business owner can now use a defined benefit plan to build assets without taking into consideration money already accumulated in other retirement plans.

§ Section 415(b)(1)(A) was amended to increase the maximum retirement benefit allowed.

§ Section 415(b)(2)(C) was amended to lower the age at which the maximum retirement benefit could be received.

Together, these changes allow small business owners to now contribute more to a defined benefit plan.


·  Are takeovers of existing defined benefit plans permitted?

Yes, but the benefit from the prior plan will need to be considered in the determination of the new benefit.


·  What is the role of Sheffler Consulting Actuaries, Inc.?

Sheffler Consulting Actuaries is the third party plan administrator, also known as a ‘TPA”. It provides the plan document, the actuarial calculations, prepare all pension plan tax forms and answer any questions that may you have. It doesn't provide investment or tax advice.