The review of retirement plans that we have embarked upon seems to be inline with the back to school momentum that animates our youth at this time of year. We hope the topic will prompt you to go back and school yourself on the best pension plan available for you as soon as possible.

If you are already participating in a pension plan, you may consider other options as well. For instance, this newsletter is all about the defined benefit plans.

As a quick reminder from our previous newsletter, defined benefit plans are among the qualified retirement plans (QRP), which means that they receive special tax treatment and are thus subject to strict government regulations. Specifically, they are certified by the Internal Revenue Code Section 401(a) of the IRS and the Employee Retirement Income Security Act of 1974 (ERISA).

Defined benefit plans provide a fixed, pre-established benefit for employees at retirement. Defined benefit plans can be funded or unfunded.

In an unfunded defined benefit plan no assets are set aside and the benefits are paid for by the employer or other pension sponsor as and when they are paid. This means that they pay retirement incomes from the employer’s current income - tax revenue in the case of the public sector - rather than setting assets aside to pay for pensions.

An unfunded pension plan, more appropriately an underfunded pension plan, is a defined benefit pension plan that does not have enough income or assets available to fund its obligated retirement benefits. Often, these unfunded plans are the result of organizations encountering budget problems or choosing not to contribute appropriate funds to the existing accounts.

In funded defined benefit plans, contributions from the employer and plan members are invested in a fund to reach a chosen level of retirement income at a predetermined future retirement date.

The amount that can be contributed annually is based on factors such as age, income, length of time before retirement and rate of return of the investment portfolio. You may have to work for a specific number of years before you have a permanent right to any retirement benefit under a plan.

A government based defined benefit pension is considered the gold standard of retirement benefits. The requirement is that you need to work for the government for 25-30 years, contribute a small portion of your salary towards the pension and in return, you get 60-70% of your working income monthly (some pensions are even indexed to inflation) during retirement.

In the private sector, defined benefit plans are often funded exclusively by employer contributions. For very small companies with one owner and a handful of younger employees, the business owner generally receives a high percentage of the benefits. In the public sector, defined benefit plans usually require employee contributions.

Generally, the employer makes most contributions. Sometimes, employee contributions are required or voluntary contributions may be permitted.

Sole proprietorships, S and C corporations, LLCs ,and partnerships are all eligible for a defined benefit plan.

Self employed business owners with high income and the goal to maximize their tax deductible retirement contributions frequently create their own defined benefit pension plan.

A contribution is required each year to fund the predetermined retirement benefit amount at the specified future retirement date. The retirement benefit amount and retirement date are determined when the defined benefit plan is established.

The plan must be set up by December 31st or the end of your fiscal year.

Generally the plan is designed to have a retirement age of 62 or age 65 and is expected to be maintained at least 3 years. You can terminate the plan prior to retirement date if your circumstances should change.

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.

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.

Here are the advantages of defined benefit pension plans:

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.

However, defined benefit plans are often more complex and, thus, more costly to establish and maintain than other types of plans. At one time, 88 percent of private sector workers who had a workplace retirement plan had a pension. That number is now around 20 percent. Here are the disadvantages:

• 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.

In general, the annual benefit for a participant under a defined benefit plan cannot exceed the lesser of:

1. 100% of the participant's average compensation for his or her highest 3 consecutive calendar years, or
   
   
2. $225,000 for 2019 ($220,000 for 2018).

The dollar amounts are subject to cost-of-living adjustments in future years.

As mentioned, for tax year 2019, the annual benefit payable at retirement can be as high as $225,000 per year. As a result, annual contributions into a defined benefit plan can be even larger than $225,000 in some cases in order to meet that level of retirement income target. On an annual basis, an actuary makes calculations to determine the amount that needs to be contributed into the plan.

Employers can usually deduct, subject to limits, contributions made to a qualified plan, including those made for their own retirement. The contributions (and earnings and gains on them) are generally tax free until distributed by the plan.Deduction limit is any amount up to the plan’s unfunded current liability.

All pension plans covered by ERISA are required to file Form 5500, Annual Return/ Report of Employee Benefit Plan, annually. An enrolled actuary must sign the Schedule B of Form 5500. The Enrolled Actuary is any individual who has satisfied the standards and qualifications as set forth in the regulations of the Joint Board for the Enrollment of Actuaries and who has been approved by the Joint Board to perform actuarial services required under ERISA.

At retirement, at reaching age 62, or upon plan termination, IRS rules generally allow participants to roll the assets into an IRA. In an IRA, assets continue to grow tax-deferred. Another option is to purchase an annuity and start receiving periodic distributions. Income taxes must be paid when distributions are received.

Payment options commonly offered include:

• A single life annuity: You receive a fixed monthly benefit until you die; after you die, no further payments are made to your survivors.
  
  
• A qualified joint and survivor annuity: You receive a fixed monthly benefit until you die; after you die, your surviving spouse will continue to receive benefits (in an amount equal to at least 50 percent of your benefit) until his or her death.
  
  
• A lump-sum payment: You receive the entire value of your plan in a lump sum; no further payments will be made to you or your survivors.

Some employers offer hybrid plans, which include defined benefit plans that have many of the characteristics of defined contribution plans. One of the most popular forms of a hybrid plan is the cash balance plan.

A cash balance plan provides employees with the option of a lifetime annuity.

Unlike pensions, cash balance plans create an individual account for each covered employee, complete with a specified lump sum. Employers specify a contribution— usually based on a percentage of the employee's earnings—and a rate of interest on that contribution that will provide a predetermined amount at retirement, usually in the form of a lump sum.

Keep up with our newsletters in the following weeks to find out more about other pension plans available to you and get ready to decide how to better fund your golden years.