Frequently Asked Questions

Defined Benefit & Cash Balance Plans
Questions & Answers


How is the contribution calculated?

There are several funding methods that the actuary can use to determine the contribution. All of the funding methods are based upon the principle of funding for an annuity benefit that will commence at the plan's normal retirement age. Therefore, most funding methods take a financial math approach of "how much do I need to fund each year, in order to replace a certain percentage (%) of my pre-retirement income to provide myself a certain level of monthly or annual income (annuity) when I retire?" Since we need an estimate of how many years the annuity will be paid (i.e., how long are you expected to live), certain mortality tables factor into the math equations.

Although all funding methods are "theoretically" funding for an annuity, most small plan sponsors are more concerned with their contribution budget, so the annuity benefit target is simply "backed into" in order to generate the desired contribution for the first plan year. It should be quickly noted that it is not required that an annuity ultimately be taken from the plan, and most small plan sponsors include a lump sum provision so they can simply roll the money to an IRA when they retire and/or terminate the plan.


What is the maximum contribution I can make under a defined benefit plan?

It depends. The maximum contribution amount is not a simple stated dollar amount, but rather the amount calculated as necessary to fund the maximum annuity benefit allowed under IRS regulations. The current maximum annual annuity is $225,000 for 2019 ($230,000 for 2020), payable at retirement ages between 62-65, assuming you have a compensation average at or above $225,000. The contribution will vary depending on your age, and how many years you have to fund the annuity benefit. The $225,000 maximum annuity is reduced for a Normal Retirement Age that is earlier than age 62.


What type of investments are allowed under a defined benefit plan?

A. Generally most arms-length third party investments available to you on a personal level are also available for plan investments. For example, stocks, bonds, mutual funds, CD's, Mortgage Notes, Real Estate Investment Transactions (REITs), unimproved land, improved land, certain limited partnerships (see below), and even Art & other Collectibles are acceptable, although certain annual appraisals would be required on these latter investments. The plan document must specifically allow for these investments, but most documents are pretty broad in this area. Even though you will likely be able to invest pension money in all the above investments, you must be careful to not use the investments for your own personal use. For example, if you purchase certain artwork with your pension funds, you should not hang the art in your home, but should keep it safely stored in a vault. The same would apply to an antique car purchased with pension money. You would not be able to drive the car around for your personal use; it would need to be kept properly stored in a garage or on display where it could reasonably expect to appreciate in value.

B. You cannot use plan money to invest in your business or home (other than a qualified participant loan that meets certain requirements, some of which are described below).


Can I borrow money from the plan?

A. Yes, if you design your plan to expressly allow for loans and adopt a loan program. Before 2002 unincorporated owners and S-Corp owners could not receive loans under a qualified retirement plan. However, for 2002 and thereafter, tax law changes allow for any owner to have a plan loan subject to the limitations below. Loan documents must be prepared and signed before a loan can be taken.

B. The maximum loan amount is the lesser of (a) 1/2 of your vested benefit or (b) $50,000. Loan terms generally allow no longer than five (5) years for repayment, with quarterly payments (or more frequent payments) of principle and interest. Longer term loans are available for buying principal residence.


Which employees must be covered under the plan and does that include leased employees?

A. Generally, all common-law employees and leased employees who have met the plan's eligible requirements must be considered for plan participation, although only 70% of those meeting the eligibility requirements must be covered. Those not benefiting must be excluded from the plan by a job title or classification that is not deemed to be discriminatory.

B. In very small companies, excluding an employee by job classification may not be possible if such exclusion causes the coverage of eligible employees to fall below 70%. For example a company with only 3 employees could not exclude even one (1) employee and pass the 70% coverage requirement (2/3 = 66%).


Can contribution amounts change each year and are they required?

A. Contributions under a defined benefit plan are generally required. There are exceptions for plans that are over funded, or have chosen to "freeze" the benefits by plan amendment and have sufficient assets to cover the frozen benefits.

B. Contribution levels can also be modified by timely adopting plan amendments. Usually this needs to be done before the end of the sixth month in the plan year (e.g.; before 6/30 for calendar plans) or else full-time employees will already earned the benefit under the old formula.

C. There may be some limited ability for the actuary to modify certain funding assumptions, within reason, which can change the contribution level somewhat and possibly meet your budget.


When does the required contribution have to be made?

The contribution must be made by the earlier of:



  • The due date of your tax return that reflects the tax deduction (including any extension).

  • 8 1/2 months after the plan year end.


When can I withdraw money from the plan?

A. A "distributable event" is required to justify a distribution. Distributable events include: attainment of normal retirement age, termination, death, disability or plan termination.

B. Participant loans may be available (see Question 4).

C. You should always contact us before withdrawing any money from the plan, as there are election forms that need to be completed before taking any money out of the plan.


Are the benefits under the plan guaranteed?

A. Certain plans are insured by the Pension Benefit Guaranty Corporation (PBGC) and must file annual forms and make premium payments. Plans that fall in this category have some or all of their benefits guaranteed by this government insurance corporation. The premiums are generally pretty modest.

B. Many small professional organizations are exempt from PBGC coverage and, therefore, cannot be covered by the PBGC. Benefits under these plans are not guaranteed, although many are still protected from creditors under bankruptcy proceedings either via State bankruptcy statutes and/or through a 1992 U.S. Supreme court ruling (if meet similar fact pattern).


Can I terminate the pension plan and when can I do so?

A. Generally, a pension plan should be kept long enough for the IRS to consider the plan to have been intended to be a permanent retirement program. There is no required number of years, but we feel that keeping the plan for 3 - 5 years should satisfy this requirement. Terminating the plan before this time may still be acceptable to the IRS if retirement occurs, or the business is sold or closed down or there are other extenuating circumstances.

B. The plan termination is done through a series of steps that include:


•  Preparation of an Agreement to Terminate, Action of the Board of Directors, and a Notice to participants of the proposed termination date;
•  Calculation and preparation of benefit statements for all participants;
•  Preparation of Election Forms and distribution instructions;
•  Forms 1099R and 945 are prepared in January or February of the year following the plan termination.
•  IRS approval on the plan termination is available, but not required.


What are the available vesting schedules?

A. Most small defined benefit plans are top-heavy plans (i.e., more than 60% of the overall benefits are going to the owners) so the following are the two slowest vesting schedules allowed for top-heavy plans (you can always customize a vesting schedule to be MORE generous than these shown).


                          "2-20" Schedule                                                                     "3-Year Cliff Schedule" 
                            0-1 Year = 0%                                                                         0-2 Years = 0% 
                            2 Years = 20%                                                                        3 + Years = 100%
                            3 Years = 40%   
                            4 Years = 60%   
                            5 Years = 80%   
                            6 Years = 100%


What is the longest eligibility waiting period you can use?

If you want to use one of the above vesting schedules then one (1) Year of Service is the longest eligibility waiting period. A Year of Service is generally defined as a twelve month period in which the employee works 1000 hours (equates to about 20 hrs. per week) so that even some part-time employees will qualify for the plan if they work 1000 hours per year.

One alternative is that you can use a two (2) year eligibility waiting period but ONLY if the employee becomes 100% vested IMMEDIATELY upon entry into the plan (i.e., you can’t use a vesting schedule).


Do I have to be incorporated to sponsor a retirement plan and claim deductions for contributions?

No. A plan can be sponsored by any type of business entity (including most non-profit organizations) whether or not incorporated. This may include Sole Proprietorships, Partnerships, Limited Liability Company, S-corporations, C-Corporations, and professional corporations.

Under any of these types of entities the contribution that is calculated within IRS prescribed limitations is 100% deductible. Unincorporated entities with employees generally split the deduction by taking part of the deduction on their business return for their employees (e.g., Schedule C) and the remainder on their personal return (I.e., Form 1040) for their own personal contributions.


What is a cash balance plan?

A cash balance plan is sometimes known as a 'hybrid' plan because it contains features of both qualified defined contribution and defined benefit plans. Technically, it is a defined benefit plan and offers the opportunity for larger tax deductions and accelerated retirement savings (subject to IRS limits). However, a cash balance plan has an account for each participant. The account grows annually when annual contributions are made and with interest credits. The amount of a participants contribution and the interest credit are outlined in the plan document. Contributions can be defined in the plan document as either a percentage of pay or a flat dollar amount.

The participant contributions and interest credits are shown on an annual participant statement. This is very similar in appearance to a 401(k) profit sharing plan, therefore it is easier for participants to understand and appreciate. When a participant terminates employment, they are eligible to receive their vested account balance.


6530 N. 16th St.

Phoenix, AZ 85016-1306

Telephone: 602-944-1515




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