Defined Benefit Plans
Defined benefit plans promise a specific benefit to each participant at retirement, for example, $3,000 a month.
Funding Requirement for Defined Benefit Plans
Because a defined benefit plan promises to pay a specific benefit to each plan participant upon retirement, the plan must be adequately funded to insure the money is actually there when the time comes.
The question is...
How does the employer know how much money to pay into the plan each year so that the money is actually there to provide the promised benefits when the time comes?
This is where the services of an actuary come in.
An actuary performs a computation designed to determine the annual funding requirement for the plan. The computation involves variables, such as estimated earnings on plan assets, rate of inflation, time line for participants, and amount of benefit promised. Then end result is the annual funding requirement.
Minimum Funding Requirements
If your plan is subject to the minimum funding requirements, you, as the employer, must make quarterly installment payments of the required contributions.
If you don't pay the full installments timely, you may have to pay interest on any underpayment for the period of the underpayment.
Due dates for installments payments of required contributions:
The due dates for the installments are 15 days after the end of each quarter.
For a calendar-year plan, the installments are:
- April 15
- July 15
- October 15
- January 15 (of the following year).
Each quarterly installment must be 25% of the required annual payment.
Extended period for making contributions:
Additional contributions required to satisfy the minimum funding requirement for a plan year will be considered timely if made by 8 1/2 month after the end of that year.
Annual Benefit Limit Under a Defined Benefit Plan
For defined benefit plans, rather than a contribution limit, the limit is placed on the benefit amount that may be provided under the plan.
For tax year 2016, 2015,,and 2014, the annual benefit for a participant under a defined benefit plan cannot exceed the smaller of the following amounts:
- 100% of the participant's average compensation for his or her highest 3 consecutive calendar years.
The annual contribution amount that is required to provide the future benefit is computed by an actuary each year. After the actuarial computation is complete and contribution amount is known for the particular year, the employer then funds that amount.
This process designed to ensure that the funds are actually there when the time comes for each plan participant to receive his pension benefit.
- Return to the Retirement Plans Table of Contents to find related links