How defined benefit plans supercharge the powers of retirement benefit offerings

High-income owners of small and mid-sized businesses often face challenges maximizing their own retirement plan contributions while also affordably covering contributions to employee retirement benefits.

Adding an annuity-based or cash-balance defined benefit (DB) plan to an employer-sponsored defined contribution (DC) plan can be a win-win solution to help maximize employer tax advantages while offering a highly competitive retirement benefit that can help organizations attract and keep quality employees.

Unlike DC plans, DB plans are designed to provide a specific, guaranteed retirement income benefit based on factors including employee salary, age and years of service. Actuarial assumptions and computations are used to calculate definitely determinable benefit amounts as well as the employer contributions required to achieve the benefit.

Because DB plans provide a fixed, predetermined retirement benefit, they’re particularly attractive to employees. And businesses can benefit from DB plans’ generally much higher tax-deductible contributions than 401(k) and similar plans to help employers reduce companies’ tax liabilities.

And business owners don’t have to choose between the two plan types.

By offering both DC and DB plan types, plan sponsors can help maximize tax savings, shift some of the retirement savings burden off employees’ shoulders and effectively help prepare for the business owners’ own retirement, with potential flexibility to front-load contributions and/or allocate the majority of the benefit to the business owner.

Here are some of the most important factors plan sponsors and financial professionals should be sure to discuss:

Build a highly competitive retirement offering for employees

Tax deductibility is just one of several advantages businesses can realize by adding a DB plan to their retirement benefits mix.

A guaranteed income at retirement adds a measure of predictability that other retirement plans can’t provide, making DB plans particularly appealing to employees and job candidates. And unlike 401(k) and similar plans, DB plans are most often funded by employer contributions, which helps alleviate some of the burden on employees and improve their retirement readiness.

In addition, DB plans can be designed with provisions that can help meet specific business goals — to help reduce tax expenses, maximize benefits for business owners and control overall plan costs. Plans can be designed so that substantial retirement benefits are accrued within a short period of time, and vesting can be immediate or spread out over a period of years.

Optimize tax efficiency by combining contribution limits

The increased contribution limits of DB plans create an opportunity for business owners to save more for retirement and potentially reduce their taxable income by making larger tax-deductible contributions. This can be particularly beneficial for high earners who may have already maxed out their contributions to DC plans yet want to save more for retirement and further reduce their tax liability.

Generally, the Internal Revenue Service (IRS) limit for annual DB plan benefits is the lesser of these two:¹

1. 100% of the plan participant’s average compensation for their highest 3 consecutive calendar years
2. $265,000 (in 2023)

Amounts are subject to annual cost of living adjustments.

DC plans, on the other hand, are subject to lower deduction limits. An employer’s total annual deduction for contributions to a DC plan can’t exceed 25% of the compensation paid or accrued during the year to eligible employees participating in the plan.² 

Total annual contributions to all of an employee’s DC accounts maintained by a single employer are limited, not to exceed 100% of the plan participant’s compensation, or $66,000 ($73,500 including catch-up contributions for employees age 50 and over).² And the amount of compensation that can be taken into account when determining contributions is limited to $330,000 in 2023.²

DB plans are subject to certain nondiscrimination rules to ensure the plan does not discriminate in favor of highly compensated employees in terms of coverage, benefit amounts, rights and plan features. The complexity of DB plans, coverage testing and actuarial services typically require professional administration to ensure compliance.

Get the right support to make the most of the opportunity

Every organization is unique, and so are the retirement and tax planning needs of business owners. That’s why it’s so important to leverage investment, actuarial, plan design and administrative support from an experienced leader in DB plans. 

Cuna Mutual Group is here to help with every detail.  Our actuarial experts can help optimize plan design to meet business needs and employer retirement goals. And our administrative services and co-fiduciary protection can help maintain plan compliance.

SOURCES
¹IRS.gov, Retirement Topics – Defined Benefit Plan Benefit Limits, October 26, 2022.
²IRS.gov, Retirement Topic – 401(k) and Profit-Sharing Plan Contribution Limits, October 25, 2022.