Defined Benefit or Defined Contribution? That Is The Question.
In an earlier posting I wrote about the value of defined benefit pension plans.
I mentioned that for some closely-held companies it's not necesarily a question of either/or. It can be both a defined benefit plan and a defined contribution plan (profit sharing or 401k) for those business owners "hearing footsteps", i.e., getting closer to retirement with not enough retirement savings - the qualified plan rules being satisfied, of course.
Several individuals who read the posting contacted me regarding the feasibility of their companies adopting a defined contribution plan to supplement their existing defined benefit plans. While every company’s situation is different, following are some general concepts I provided them which you might find helpful.
Deductibility Issues
The first step would be to determine the extent to which an employer could contribute and deduct contributions to both a defined benefit pension plan and a defined contribution plan. The general rule is that while a company can contribute/deduct the amount necessary to meet minimum funding requirements to a stand-alone defined benefit plan, contributions/deductions are limited to a maximum of 25% of compensation if both types of plans are maintained.
Please note, however, that a 2001 law change allows 401(k) contributions to be disregarded for purposes of deductibility. Thus, we have several clients with defined benefit plans that have adopted 401(k) plans to which only employees contribute. Caveat: The 401(k) plan must pass the 401(k) non-discrimination tests.
Plan Design Issues
Does that mean that if combined contributions would exceed the 25% limit, a defined contribution plan funded by the employer could not be adopted? Not necessarily! The 25% limit applies only if the same individuals are participants in both plans. We have clients that maintain a defined benefit plan for one group of individuals and a defined contribution plan, i.e., profit sharing/401(k) plan for another group. The deduction limits in this situation are minimum funding requirements for the defined benefit plan and 25% of participants’ compensation in the defined contribution plan. Thus, the overall 25% limit is not applicable. Please note, however, that a separate set of qualified retirement plan non-discrimination tests must be met in such situation.
To the extent to which such a combined retirement plans scenario is available is, of course, a matter of facts and circumstances for each employer.