Traditional Defined Benefit Plans
Typically, traditional Defined Benefit plans provide for an annual benefit expressed as a percentage of either a participant’s career average compensation or some form of final average compensation (3 years or 5 years) at a participant’s normal retirement age. The plan trustees are responsible for investing the assets in a conservative manner such that the money will be available to fund participant benefits at retirement or termination of employment.
Traditional Defined Benefit plans have become less popular in recent years as a result of a change in the law allowing Cash Balance plans a more secure legal status.
However, in sole-proprietorships or in companies with a single owner, these plans are still prevalent since they are less expensive to set up and operate than Cash Balance plans.
Generally these plans are used by a plan sponsor where the purpose of the plan is to fund a retirement benefit for an older owner or professional since the amount of contributions can be upwards of four times greater than contributions allowed under qualified Defined Contribution plans.
The IRS requires that these plans make at least minimum required contributions annually to the plan. As a result of the Pension Protection Act of 2006 (PPA), the terminology and methodology surrounding the funding of these plans has changed significantly.
When these plans cover any participants other than an owner or spouse of a non-professional entity or in excess of 25 plan participants at a professional entity, they are subject to the rules of the Pension Benefit Guaranty Corporation (PBGC).
Certain restrictions may be imposed on Defined Benefit plans, whether or not subject to PBGC, in a given year depending upon their funding status for that year.
These plans are more expensive to design and administer than Defined Contribution plans. An Enrolled Actuary licensed by the Federal Government is required to certify the funding status of the plan and sign an attachment to the plan’s tax filing annually.
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