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Guide to Defined-Benefit Pension Plans for Sole Proprietors
A defined benefit plan helps you set aside lots of money quickly
The downside, however, is that these plans are more complex and costly to administer than defined-contribution plans, such as 401(k) plans, and they also require lump-sum distributions at retirement. With those caveats in mind, there are some enticing plan benefits, including:
- Guaranteed retirement income.
- Asset protection from creditors.
- Larger income tax deductions than defined-contribution plans.
- Fast accumulation of retirement income.
- Plans are insured by the Pension Benefit Guaranty Corp. (PBGC).
Action Steps
The best contacts and resources to help you get it done
Define your target benefit
Your target benefit can be based on a fixed percentage of your annual income, or you can choose a flat monthly dollar amount.
I recommend:
Use retirement and savings planning calculators at FinancialPlanningToolkit.com to zero in on your retirement goals.
File appropriate forms
With a defined-benefit plan, you must file certain IRS forms annually and pay premiums to the PBGC, which insures the plan. These costs can drag down returns, unless you're contributing large sums of money
I recommend:
Download Form 5500 and a Schedule B from the IRS. Note that an enrolled actuary must sign the Schedule B.
Hire an administrator and actuary
Because defined-benefit plans are so complex, you'll have to hire a retirement plan specialist to administer the plan and an actuary to calculate contributions and valuations. Many major retirement plan providers offer both these services.
I recommend:
Pension Consultants Inc., which offers plan administration and on-staff actuaries, provides a printable copy of a sample defined-benefit plan for a company owner — just click on 'types of plans' then on 'defined-benefit' to download it. Fidelity Investments also offers both plan administration and actuarial services for small companies.
Consider fees
Since defined-benefit plans have gone mainstream, there's more help available when implementing a plan. However, you'll want to note advisor fees.
I recommend:
Check out a fee table for Charles Schwab's Personal Defined-Benefit Plan; you'll find a link to it by scrolling to the bottom of the page.
Consider a 412(i) plan
Traditional defined-benefit plans allow for up to approximately $160,000 in annual contributions. Another type of defined-benefit plan that's gaining popularity is called a 412(i) and lets you contribute significantly more each year — up to $450,000 annually with some providers.
I recommend:
Schedule a private Webinar on 412(i) plans from The Hartwood Group.
Choose additional retirement plans
Having a defined-benefit plan doesn't exclude you from holding other types of retirement plans as well. Consider other options, such as a 401(k), SEP or Roth IRA.
I recommend:
ShareBuilder4019K.com offers a retirement plan for sole proprietors that combines the features of a defined-benefit plan with the benefits of an individual 401(k) plan.
Tips & Tactics
Helpful advice for making the most of this Guide- Proposals made in Washington may simplify plan administration considerably in future years.
- Plans must be opened by the end of your company's fiscal year to make contributions for that year.
- Remember, even if your business is losing money, you must fund your plan at least quarterly.
- Avoid aggressive plan investments, because if you have losses, you'll have to make them up through dramatic increases in contributions.
- Think of a defined-benefit like a mortgage: the capital you need determines your annual payments.
- If you plan on hiring in the future, note that tax codes may require you to make contributions for employees.
