Defined Benefit Plans

The Defined Benefit plan has experienced a recent resurgence in popularity for three main reasons: Family Aggregation repeal, 415(e) limitation repeal, and EGTRRA. For example, the repeal of the Family Aggregation rules means that a husband and wife are no longer treated as one person. Without this marriage penalty, each of them may now accumulate a full benefit in their own right, based on their own earnings history. Also, companies that previously sponsored a Defined Benefit plan and wanted to start a new one would have their benefit accruals in the new plan reduced by the amount of their benefit accruals in the old plan. Now, with the repeal of the 415(e) limitation, a company can start a new Defined Benefit plan and it will be treated separately. Finally, the Economic Growth and Tax Relief Reconciliation Act of 2001 increased the annual benefit limit under a Defined Benefit plan to $165,000 in 2004 and indexed it for inflation.

Often referred to as the traditional pension plan, a defined benefit plan provides a guaranteed retirement benefit for each participant. This retirement benefit is generally designed to replace up to 100% of the participant’s pre-retirement income when combined with social security benefits the participant will receive in retirement. The retirement benefit is stated in terms of a specific dollar amount or percentage of pay to be paid annually during retirement. Calculating the retirement benefit is very complex. Therefore, the services of a third party administration firm or an actuary are required.

Each year, the actuary will calculate each participant’s retirement benefit - the future benefit each participant is projected to receive in retirement. This retirement benefit is based on various factors such as earnings, age, and years of service with the employer. Then, the actuary will calculate how much the employer must contribute to the plan in order to fund the projected retirement benefit.

The employer must make an annual contribution, even for years in which there is no profit. The maximum annual contribution to a defined benefit plan is one which will produce a retirement benefit equal to the lesser of $165,000 (for 2004) or 100% of the participant’s average compensation for the three highest consecutive wage earning years. As shown in the following chart, Defined Benefit plans generally produce a significantly higher deductible contribution amount than deferred compensation plans.

Employee	Age	Earned Income	Pro-Rata	Age Weighted	Cross Tested	Defined Benefit
Owner	58	$200,000+	$40,000	$40,000	$40,000	$157,455
Staff 1	38	35,000	5,852	1,369	3,927	9,100
Staff 2	36	25,000	4,180	831	2,805	5,200
Total			$52,000	$42,200	$46,732	$171,755

All Defined Benefit plan assets are held in one pooled account, as opposed to individual investment accounts for each participant. Individual participants may not be permitted to have a voice in investment direction. Therefore, the employer assumes all risk of investment performance. To protect the plan participants, the Pension Benefit Guarantee Corporation (PBGC) insures most defined benefit plans.

Retirement benefits under a defined benefit plan can be subject to a vesting schedule. A participant who leaves his job before he is fully vested will not get his full retirement benefit. Retirement benefits are normally paid in the form of a single life annuity, with no ancillary benefits, commencing monthly distributions at age 65. Optional forms of payment include a qualified joint and survivor annuity or a lump-sum distribution.