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• Vesting: Just because money goes into the Plan for an employee does not make it their money. Employees vest, or earn, their
benefits over time. The typical vesting schedule is a “ 2-20” schedule, meaning if the participating employee leaves your company,
he or she is entitled to 0 percent of their benefit if they’ve worked
for you less than two years. After two years they are 20 percent
vested, and their vesting increases by 20 percent annually until
they are 100 percent vested after 6 years. Let’s say an employee
leaves after three years. They are 40 percent vested and they forfeit 60 percent of their benefit’s value. Those forfeited assets stay
in the plan. There is one caveat: vesting accelerates to 100 percent
on death, retirement, or plan termination.
• Tax Deferred Growth: All assets in a qualified plan are tax
exempt. Under ERISA, pension monies have to be held “in trust”
for the participating employees. The trust is a tax exempt trust, so
no taxes are due on plan earnings. But let’s be clear, taxes are due
on these monies when you take them out of the plan. However,
in many circumstances the taxable receipt of funds and therefore
taxes can be delayed up to age 70 ½ when you must begin taking
RMD’s, or Required Minimum Distributions.
With all the above benefits, what is the downside? Nothing is
the “silver bullet.” Here are some items to consider: A DB plan,
like a 401(k), has annual reporting requirements, actuarial certi-
fication, etc. The cost for a DB plan is typically about twice what
a 401(k) plan costs. Unlike other DC plans, defined benefit plans
have required contributions. DB plans are not set up for a one-
time contribution. When establishing the plan, consider this is an
item that will be added to overhead. The fact that you, the busi-
ness owner, get the bulk of the contribution is great.
The moral of the story? For a business owner that has a high net
worth and a large taxable income from their business, a DB plan
takes steps to minimize income taxes, protect assets and personal
wealth from judgment creditors, and all with up-front approval
from Internal Revenue.
Don’t assume anything. Obtain an illustration of a DB plan cus-
tom designed for your particular situation. Get your CPA involved
in the decision making process too. When making a business
decision, go in with all the facts and see the numbers in black and
white. You will likely be pleasantly surprised.
William H. Black, Jr. has been in the pension administration business for 35 years. The firm Pension Services, Inc. administers both
defined contribution and defined benefit plans, employs an ERISA
attorney and an Enrolled Actuary. Bill as spoken on retirement
plans, written articles for industry journals, and has appeared on
financial radio shows discussing the topic of retirement. You can
reach him at firstname.lastname@example.org.