A defined cash benefit plan is a pension plan which allow you to make contributions that are tax deductible up to a maximum amount. Contributions which are allowed are often dependent on the person’s income and age. They can be used by companies with employees or by someone who is self-employed.
How Defined Benefit Plans Work
Most of these plans are funded by the employer, but some may require employee participation. The amount added is usually based on a percentage of the employee’s salary. For instance, the employer may contribute 5 percent of the gross income to the plan. Employees may be required to work a certain number of years to become vested in the plan. For instance, after five years, they may be 80 percent vested. After ten years, they may be 100 percent vested.
If the employee leaves the company, they can take the money from the plan with them. If they are 80 percent vested, they take 80 percent of the money.
The Difference in Defined Benefit Plans and Traditional Contribution Plans
The main difference between the two types of plans is how they pay out. With a defined benefit plan, the employer promises to pay out a specific amount regardless of how the investments of the money fare. The employee is guaranteed a retirement payout of a certain amount which enhances their retirement planning.
With a defined contribution plan, such as a 401k plan, the amount an employee receives at retirement can vary. It will depend on the investments chosen and how they performed.
What Employers Need to Know
If you’re a business owner and considering establishing a defined cash benefit plan, you need to know some basic information. These plans are usually quite complex, which is why it’s a good idea to have your accountant help you set one up and manage it.
You can include this benefit along with other retirement plans, such as a 401k. You can set up a defined benefit plan regardless of your size or the number of employees you have. However, you cannot decrease benefits retroactively once you have set up a certain amount to be paid. You will also need to file Form 5500 with a Schedule B every year.
There are several benefits to establishing this kind of plan for employees. Employers can contribute more each year than with other retirement plans, which means they can also deduct more. A significant amount of money can be provided in a short amount of time for employees. This option might fit into an overall business plan which offers subsidized early retirement for employees.
This plan also encourages loyalty and reduces turnover for many businesses. Employees will continue to work with the same company until they are 100 percent vested. For some, they will want to stay even longer because they will continue to grow their retirement benefits. This benefit may enhance a company’s strategy and reduce the costs associated with frequent turnover.
Several downsides exist with this plan as well. It’s a costly option and more complicated to administer than other retirement plans. The employer may have to pay an excise tax if either the minimum contribution requirement isn’t met or if the maximum amount is exceeded.
Tiered Benefits
One of the attractive features of the cash balance plan for businesses is the tiered level of benefits. Employees are divided into categories or tiers based on their position within the company. Each tier receives a different level of payment. This option is attractive to businesses who have various levels of ownership and partnerships such as medical practices and law firms. It allows businesses to reward the most valuable employees while minimizing contributions to other employees and still meeting the IRS rules.
A defined cash benefit plan may be a viable option for a business to provide retirement benefits to its staff. It can be especially attractive when combined with other retirement plans to increase the amount received at retirement age. It’s a suitable option for both traditional businesses with employees and those who are self-employed. However, it is a complex and costly retirement benefit, which is why it’s important to work with a tax preparer or accountant to establish and manage such a plan.
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