There are two general types of pension plans — defined benefit plans and defined contribution plans. In general, defined benefit plans provide a specific benefit at retirement for each eligible employee, while defined contribution plans specify the amount of contributions to be made by the employer toward an employee’s retirement account. In a defined contribution plan, the actual amount of retirement benefits provided to an employee depends on the amount of the contributions as well as the gains or losses of the account.
Defined benefit plans provide a fixed, pre-established benefit for employees at retirement. Employees often value the fixed benefit provided by this type of plan. On the employer side, businesses can generally contribute (and therefore deduct) more each year than in defined contribution plans. However, defined benefit plans are often more complex and, thus, more costly to establish and maintain than other types of plans.
If you establish a defined benefit plan, you:
- Can have other retirement plans
- Can be a business of any size
- Need to annually file a Form 5500 with a Schedule B
- Have an enrolled actuary determine the funding levels and sign the Schedule B
- Can’t retroactively decrease benefits
Pros and cons
- Substantial benefits can be provided and accrued within a short time – even with early retirement
- Employers can contribute (and deduct) more than under other retirement plans
- Plan provides a predictable benefit
- Vesting can follow a variety of schedules from immediate to spread out over seven years
- Benefits are not dependent on asset returns
- Plan can be used to promote certain business strategies by offering subsidized early retirement benefits
- Most costly type of plan
- Most administratively complex plan
- An excise tax applies if the minimum contribution requirement is not satisfied
- An excise tax applies if excess contributions are made to the plan
Generally, the employer makes most contributions. Sometimes, employee contributions are required or voluntary contributions may be permitted.
Contribution and benefit limits
Benefits provided under the plan are limited. Generally the benefit limits are higher than those allowed in Defined Contribution Plans. An Enrolled Actuary is needed to determine the Contribution and Benefit Linmits
Annual filing of Form 5500 is required. An enrolled actuary must sign the Schedule B of Form 5500.
A defined benefit plan may permit participant loans.
Generally, a defined benefit plan may not make in-service distributions to a participant before age 62.