J.G. Gaston & Associates, Inc.
Actuarial Consulting Services for Business, Government, and the Individual

Defined Benefit Plans

Description

Defined Benefit Plans provide a retiremnent benefit payable as a lifetime annuity. Benefits are often a function of a participant's final average compensation and their years of employment or years of participation. While some plans offer a lump sum upon retirement, in lieu of the annuity form of benefit, the plan must express its benefit in the form of a lifetime annuity.


An example of a defined benefit plan is as follows:


Final average earnings: $36,000


Years of service: 10 years


Benefit formula: 5.0% per year of service


Monthly defined benefit for life: $36,000 x 10 years x 5.0% / 12 = $1,500

Why provide a guaranteed lifetime benefit for my employees?

In our area of defined plan practice, we are often dealing with a closely held corporation which has one or more principals who will participate in the defined benefit plan. In certain situations, defined benefit plans offer unique opportunities which are not available in other qualified retirement plan designs. The primary advantage of a defined benefit plan is the ability of the principal to earn a benefit which can have a value in excess of the maximium contribution limits under ยง415 for defined contribution type plans ($51,000 for 2013). If the principal is willing to offer this guaranteed benefit to other employees in order to take advantage of higher limits, then a defined benefit plan may be a good fit. If there are multiple principals, a cash balance plan may be a better option.

Illustration

The following is an illustration of a defined benefit plan.



 
Employee Age

Annual

Compensation

Rate

Projected

Annual

Benefit

Reserve

Required

Age 62

Total

Annual

Contribution

Principal 52 255,000 195,000 2,472,561 170,420
Sub-total   255,000     170,420
Staff1 35 45,000 73,837 936,237 11,032
Staff2 30 40,000 72,464 918,828 7,395
Staff3 25 35,000 70,005 887,653 4,989
Sub-total   120,000     23,416
Grand Total   375,000     193,836
Ratio of Pirincipal to Employee        
7.3 to 1

 

Provisions, Assumptions, and Notes


Period for Final Average Compensation: 3 years

Normal Retirement Age: Age 62

Benefit Formula: 8.25% per year of service, up to 25 years

Vesting: 6 year graded

Normal Form of Benefit: Straight life annuity


Investment Return: 6.00% per annum

Projected Salary Increases: 2.00% per annum

Mortality Table: 1994 Reserving, projected to 2002


Benefits for staff members are capped at 100% of projected final three year average compensation at age 62.

Actual plan costs for staff members may be less than shown as the plan would likely be terminated upon retirement of the principal.