| A defined benefit plan promises to pay participants a specified monthly income when they retire. The amount of monthly benefits is usually based on the participant's pay and years of service. A defined benefit plan can provide for a lifetime annual retirement income of up to the highest consecutive three-year average compensation or $185,000, whichever is less. The $185,000 limit applies to plan years ending in 2008 and is adjusted each year to reflect changes in the cost-of-living index.
The plan sponsor must make certain that there is enough money in the plan to pay the promised benefits. Annual contribution levels are determined by an actuary based on actuarial assumptions about future pay increases, investment performance, years until retirement and life expectancy after retirement.
Contributions to a Defined Benefit Plan are mandatory and must satisfy minimum standards. Larger contributions must be made on behalf of older participants because an older participant has fewer years remaining until retirement. This can be advantageous to key executives, who are often older than the other participants.
Advantages
- Contribution for executives can be substantially higher in a defined benefit plan than in other types of retirement plans.
- Defined Benefit plans tend to favor older, higher-paid employees.
Possible Disadvantages
The promised benefit must be provided to all participants regardless of the actual investment performance of the plan. Poor investment performance could result in increased contribution requirements.
Termination of a defined benefit plan that is over-funded could result in an excise tax to the employer ranging from 20% to 50% on the excess assets.
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