Defined Benefit Plans Reconsidered

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BERLIN – If you think defined benefit plans are only for big businesses, take another look. An increasing number of small and midsize businesses are considering these plans as an alternative to the 401(k) or other more conventional retirement savings tools — although under current regulations, they can also be used very well in conjunction with a 401(k).

But unlike a 401(k) plan or other defined contribution plan, defined benefit plans promise retired employees — including owners themselves—a predefined benefit when they retire that’s based on age, earnings and years of service. Principals of sole proprietorships, limited partnerships, and C or S corporations are now using defined benefits to rapidly accumulate significant retirement funds — sometimes in just a few years.

Based on their design, their vesting schedule and means of calculating benefits, defined benefit plans typically work well where an employer is seeking the largest business deduction and the company’s key employees are older and longer tenured. Often a defined benefit plan, in conjunction with a 401(k) plan, can benefit both the higher-earning owners as well as provide a sound benefit for rank-and-file employees.

And the plus side of the equation grows with these other advantages of defined benefit plans:

(BULLET)Useful at tax time. “Defined benefit plans let small-business owners defer taxes and make a much larger contribution than they could with a 401(k), an Individual Retirement Account or SEP,” says Cynthia Hayes, a Managing Director in the Merrill Lynch Retirement Group. The numbers for defined benefit plan members are impressive: In 2007, the maximum deduction with a SEP is $45,000.

(BULLET)Boon to late bloomers. Hefty deductions make defined benefit plans attractive to business owners who are behind on their retirement planning — particularly those in their mid-40s and up.

Defined benefit plans do have some downsides. For example, Hayes points out that a business owner must fund the plan consistently — whether or not the business is profitable. Also, companies that default face federal penalties. “And if the plan balance is reduced due to investment losses resulting from market declines, the employer may need to increase contributions to meet funding level requirements,” said Hayes.

(The writer is a Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-9084.)

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