Defined Benefit Plans
Defined Benefit Plans allow employers to assure employees of their retirement income by defining the benefit at retirement age. The amounts that participants will receive at retirement are determined (or defined) upon becoming a participant in the plan, and are not based on future investment returns. To fulfill the benefit (or promise to pay at retirement), these plans require annual contributions determined by an actuary. Defined Benefit Plans offer business owners the greatest potential for tax benefits by maximizing contributions to a plan.
Defined Benefit Plans allow employers to fund much larger contributions than 401(k) plans or defined contribution plans. The higher the employer contributions, the larger the tax deduction for contributions the employers receive.
Because Defined Benefit Plans are employer-funded plans, employees are not allowed to make contributions. Contributions to Defined Benefit Plans are not discretionary, and they are calculated each year by an actuary based on changing factors such as interest rates, current plan assets, and projected benefits.
As with any investment, employers bear risk. If the trust experiences an investment loss for a particular year, the employer may be required to fund larger contributions so that the plan is adequately funded. Secondly, because the benefits that participants receive are defined by the plan document, contributions may still be required during a plan year in which the employer does not make a profit. Lastly, there are several actuarial factors that affect the annual funding amount. These factors are not always predictable and can cause required contributions to fluctuate each year.