Defined Benefit Plan

Small business owners are often so busy building their business they have not addressed their own financial retirement strategy. Consequently, many older business owners are looking to make up for lost time in the few working years remaining.

One way to accomplish this is to establish a qualified plan. Finding the appropriate qualified plan for the business can be a challenge. It requires a careful balance to achieve maximum results on a cost-effective basis.

The plan must meet many objectives:

  • Satisfy wealth accumulation and possibly life insurance protection needs.
  • Provide substantial amounts for select employees — including owners and key executives.
  • Control outlays for other employees.
  • Maximize the tax advantage of the plan to minimize out-of-pocket costs.

Evaluating needs and employee demographics can help determine which type of qualified plan will work for a business.

A defined benefit plan is an employer sponsored qualified retirement plan. Contributions to the plan are income tax deductible for the business. No income taxes are payable until funds are distributed to the employees (other than amounts attributable to the “economic benefit” of current life insurance protection, if any).

When the plan is established, the employer will choose a benefit formula. Typically, both compensation and service are used in the formula.

A hypothetical benefit formula which will be defined in the document might call for a retirement benefit equal to 100% of the highest three years of compensation or 5% of pay for each year of service up to a maximum of 25 years.

The formula may take into account both future and past service.

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