As a small business owner, you have plenty of options if you want to provide a qualified retirement plan for your company. But now there’s a new kid on the block.
Strategy: Consider the defined benefit 401(k) plan (DB(k)). This hybrid plan blends advantages of a traditional pension plan with a regular 401(k).
Why haven’t you heard more about the DB(k)? The authority for this new type of plan, which becomes available on Jan. 1, 2010, was buried deep within the massive Pension Protection Act of 2006. But interest in DB(k) plans is expected to heat up during the coming year.
Here’s the whole story: With a defined benefit plan, such as a traditional pension plan, contributions are based on your salary, age and years of service. The company sets aside actuarially determined contributions on behalf of the employees each year. For 2010, the contributions can’t fund an annual retirement benefit exceeding $195,000 (see box below).
Because employers must pay the entire tab for pension plans, these plans have waned in popularity as more employers switched to defined contribution plans such as 401(k) plans.
With a 401(k) plan, employees can elect to defer part of their salary, up to an annual dollar limit. For 2010, the limit remains $16,500 ($22,000 if age 50 or older). The elective deferrals may be combined with matching contributions from the employer up to the annual limit for defined contribution plans. The limit for defined contribution plan contributions is $49,000 ($54,500 if age 50 or older).
All qualified plans must meet strict nondiscrimination rules ensuring that highly compensated employees (HCEs) such as yourself aren’t unduly favored, but the testing requirements for 401(k)s can be particularly onerous. To ease the burden, special “safe-harbor” rules have been established. Also, some 401(k) plans use an automatic enrollment feature designed to increase plan participation among non-HCEs.
New option: Enter the DB(k). It is available for the 2010 plan year to employers with at least two employees and no more than 500 employees.
The DB(k) combines a defined benefit plan based on final average pay with a safe-harbor 401(k).
- The defined benefit part of the plan must provide a benefit equal to 1% of the final average pay times years of service up to a maximum of 20% of final pay. (A more complex structure is required if a cash balance plan is used instead of a final average pay plan.)
- The 401(k) part of the plan requires automatic enrollment with an employee deferral of 4% of compensation. Matching contributions for HCEs can’t exceed the matching contribution rate for non-HCEs. Employees must be immediately vested in their 401(k) accounts.
If you meet those requirements, your company files only one document and one Form 5500, Annual Return/Report of Plan, each year.
Tip: The IRS expects the DB(k) will attract older owners of small companies and professional corporations and partnerships where the business owners want to ramp up their retirement and give employees a piece of the pie. This will also be a valuable incentive for job candidates if the labor market tightens.
Expect more IRS guidance soon.
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