Certain small business owners in their fifties and sixties, with a handful of younger employees, may wish to consider a Defined Benefit Plan for themselves and their employees. Often referred to as a pension plan, a defined benefit plan operates very differently than its more popular 401(k) counterpart.
Naturally, contributions are tax deductible to the business; however, the real advantage lies in an ability to far more generously fund the plan – a particularly important consideration for older owners. The typical individual contribution limit for many plan types is approximately $50,000 per year.
However, in a defined benefit plan, with an age spread between owners and employees, it may be possible to contribute several times that amount for owners. This is because older employees are much closer to retirement which requires larger contributions to fund that future “defined” benefit.
As you might suspect, a defined benefit plan isn’t a good fit for many situations. They are more expensive, complicated, and rigid than a 401(k) arrangement.
Still…future benefit payouts can be very compelling. To determine if a defined benefit plan may be appropriate for your business, consider the following factors:
Significant Profitability: Typically, these plans are not suitable for companies that are marginally profitable. Healthy and robust profits are a must.
Consistent Profitability: In addition to strong profit margins, consistent profitability is essential. Companies with “feast or famine” patterns are not optimal candidates for a defined benefit plan. Strong cash flow is typically part of this consideration.
Limited Number of Employees: Today, defined benefit plans are best suited to businesses with a small handful of employees – perhaps ten or less. Examples include smaller dental, veterinary, or other professional practices.
Conclusion: For the right business, a Defined Benefit Plan is a great way to quickly accumulate a large retirement benefit.