These are the traditional pension plan arrangements that were common years ago but have fallen out of favor — except for some large employers and labor unions. With a DB plan, annual deductible contributions are mandatory — at least until the plan becomes fully funded, which can take years.
The annual amount that must be contributed to your DB account is determined by complicated actuarial calculations. (More on that later.) What’s important to understand first is that the best candidates for solo DB plans are high-income folks (say $100,000 or more) who are approaching middle-age or older (say 45 and above). Also, you must expect to have plenty of cash during the next few years that you would be willing to pump into your retirement plan. If you don’t fit this profile, you can stop reading right now, because a DB plan isn’t for you. (A DC plan like a Solo 401(k) is what you need.) But if you do fit the profile, you’ll like the rest of this story.
The primary focus of a defined benefit plan is the determination of a projected annual benefit that is generally payable upon the retirement of the plan’s participants. The computation is complex, generally taking into account a participant’s compensation and years of service. As an example, a plan might provide that a participant is entitled to a monthly benefit upon retirement for the remainder of his or her life, computed on the basis of a percentage of the participant’s average annual compensation multiplied by (or for each) year of service. There are, of course, other means by which to compute projected benefits that are beyond the scope of this article.
As a general rule, the tax law provides that the annual benefit with respect to a participant may not exceed the lesser of $165,000 or 100 percent of the participant’s average annual compensation for his or her high three years. The law further provides that the term “annual benefit” refers to benefits that are payable annually in the form of a straight-life annuity. However, there is no reduction in the maximum limit for a joint & survivor form of annuity. Once the annual benefit has been projected, an actuarial calculation is then completed in order to determine the present value of the projected benefit. This present value amount represents the current value of the projected benefit that will be paid in the future (generally, as stated above, upon the retirement of the plan’s participants). As a very general (and intentionally oversimplified) proposition, the present value might be said to play a role in the amount that should be funded by the employer as of the beginning of the current year.
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