A defined benefit plan is most often referred to as a traditional pension plan. This type of retirement plan provides a guaranteed retirement benefit for each participant. Combined with social security, a defined benefit plan is designed to replace up to 100% of the participants pre-retirement income.
The defined benefit plan assets are all held in one pooled account and the employer must make annual contributions, even in the years which there is no profit. Individual participants may not be permitted to have a voice in investment direction, and by default the employer assumes all risk of investment performance. The federal government through the Pension Benefit Guarantee Corporation (PBGC) insures most defined benefit plans to protect the plan participants.
Retirement benefits under a defined benefit plan can be subject to a vesting schedule. A participant who leaves his job before he is fully vested will not get his full retirement benefit. Retirement benefits are normally paid in the form of a single life annuity, with no ancillary benefits, commencing monthly distributions at age 65. Optional forms of payment include a qualified joint and survivor annuity or a lump-sum distribution.
The Ideal Prospect
The defined benefit plan works well for the client who:
- is over the age of 45,
- has a stable business environment,
- has no or very few employees,
- desires the highest deductible contribution available,
- intends to maintain the plan for several years, and
- would like to receive the maximum retirement benefit a qualified retirement plan can provide