Are Defined-Benefit Retirement Plans Better for Small Businesses?

By 1st Global Staff

Imagine this scenario: Greg is a 55-year-old client who has owned a highly successful marketing firm for 20 years. He has three employees in their 20s and early 30s who make between $20,000 and $35,000 a year, while Greg takes home $200,000 a year. Greg is looking for a retirement plan that will allow the maximum contribution and provide the biggest tax deduction and savings. Greg has not saved as much for retirement as he would like because his focus has been getting his children through college. He is now ready to contribute as much as possible to a retirement plan, as he wants to retire in the next five to 10 years.

How would you advise this client?

While small business owners typically use defined-contribution plans with an elective deferral feature to provide retirement benefits to employees, defined-benefit plans may be ideal for small-business owners over 50 who are interested in saving a substantial amount of money for retirement in a short time period.

Defined-benefit plans promise a specific annual retirement benefit based on the percentage of current income the business owner wants to have at retirement, or the percentage of current income he or she can comfortably afford to contribute, up to an annual maximum of $200,000. These plans are best suited for small business owners who are at least 40, earn $100,000 or more a year, plan to contribute more than $50,000 annually to their retirement and have five or fewer employees.

Sponsoring a defined-benefit plan for employees provides them with a determined monthly benefit upon retirement. Defined-benefit plans can be structured to reward employees who stay with the company while minimizing retirement benefits to those employees with short tenures. Participants are not taxed on the retirement benefit until they actually receive a distribution from the defined-benefit plan. An added benefit to the small business owner is that employer contributions provided to a defined-benefit plan are fully deductible as an ordinary business expense.

When considering sponsoring a defined-benefit plan, small business owners must also consider the costs and expenses associated with operating a defined-benefit plan. Such expenses include:

  • Funding the defined-benefit plan
  • Retaining an actuary to determine the amount of the employer contributions
  • Insurance premiums for the defined-benefit plan if the business has more than 26 employees

However, the advantages of defined-benefit plans often outweigh these expenses for small business owners in their late 40s, early 50s or older who meet the following criteria:

  • They want to maximize their annual retirement contribution and are seeking the maximum tax deduction
  • The company has stable cash flow
  • The company has no employees, few employees or a number of employees who are significantly younger than the owner

So which plan is best for Greg? Since he has only five to 10 years until retirement, employs three relatively low-wage workers and wants to maximize his retirement plan contributions and tax savings, Greg should consider a defined-benefit plan. This solution would provide Greg with maximum contribution and deduction, which would allow him to boost his retirement savings and possibly retire sooner. 

You may like these other stories...

Remember the old joke about the devil showing a guy around Hell? There were great parties, swimming pools, and sumptuous food. The guy liked what he saw, lived a bad life and went to Hell when he died. Upon arrival the devil...
Hertz withdraws full-year forecast, cites accounting review, challengesRental car company Hertz Global Holdings Inc. said on Tuesday it is withdrawing its full-year financial forecast and expects 2014 results to be “...
Amelia Emmert, a manager in Assurance at EY, always had a quiet concern for conservation: taking little steps to make small differences to better the environment, like turning off the lights and "vampire"...

Already a member? log in here.

Upcoming CPE Webinars

Aug 26
This webcast will include discussions of recently issued, commonly-applicable Accounting Standards Updates for non-public, non-governmental entities.
Aug 28
Excel spreadsheets are often akin to the American Wild West, where users can input anything they want into any worksheet cell. Excel's Data Validation feature allows you to restrict user inputs to selected choices, but there are many nuances to the feature that often trip users up.
Sep 9
In this session we'll discuss the types of technologies and their uses in a small accounting firm office.
Sep 11
This webcast will include discussions of commonly-applicable Clarified Auditing Standards for audits of non-public, non-governmental entities.