Offering workers an employer-sponsored retirement plan can radically improve your workforce culture. Defined benefit plans also offer business owners a solution to fast-track their own financial security for retirement.
Many employees consider retirement provisions an important part of their benefits package. Likewise, many potential candidates view it as a major consideration when deciding to accept a new job. As such, implementing a defined benefit (or DB) plan that emphasizes recruitment and maximizes employee retention can help you cultivate and retain a quality workforce.
On the business side, robust retirement programs enable older workers to leave the workforce comfortably in retirement. However, employees who have not saved sufficiently often remain in their careers out of necessity. According to CNN, when given the option to invest their own retirement money, few employees invest enough to realistically cover their needs–if anything at all. Among other considerations, this delays employer efforts to promote employees and hire new talent with different skill sets.
According to the U.S. Department of Labor, the proportion of private sector employees participating in a defined benefit plan dropped from 38% to 20% between 1980 and 2008, with forecasts for DB plans only getting worse since. Although 401(k) or defined contribution plans have become the most common form of savings options employers provide in recent decades, one should not disregard the defined benefit plan.
With benefits for both employers and employees, every business should consider a defined benefit plan option.
The Defined Benefit Plan: A Primer
A defined benefit plan, also referred to as a pension plan, is a retirement plan sponsored entirely by an employer. Contribution formulas are determined by employee age, salary history, length of employment, and investment return. Companies that offer these pension plans generally hire an external investment manager to manage the portfolio.
Since the employer is entirely accountable for managing risk and investment, employees can’t withdraw funds on a whim like with a 401(k). When payout time comes, employees qualify to receive their pension either as a lifetime annuity, or at a pre-determined age in a lump sum. This would usually be around retirement age.
Even though making the account contributions and bearing the full risk may seem like a burden on the employer, there are benefits that make it worthwhile. As a business owner, a plan with a high annual contribution level allows one to set aside more money than a typical 401(k). Since contributions are tax-deferred, the tax-savings element of the plan may also prove beneficial.
Meanwhile, the situation is equally appealing to employees, as it delivers retirement income with no effort, decisions, or responsibility on their part. A defined benefit plan often gives employers and employees more surety in their financial planning.
Defined Benefit Plan Vesting
Defined benefit plans predetermine authorization time frames for full or partial pension payouts. Employers and employees alike should be clear on vesting schedules, as these may differ between companies or individuals. If an employee contributes part of their salary to a pension, they own those contributions fully, regardless of the time they exit the company. However, employer contributions are owned by the company until the employee is fully vested.
Federal law groups pension vesting in a defined benefit plan into one of two groups: cliff vesting or gradual vesting. (There are exceptions that pertain to government and church plans, as well as vesting alterations due to employment breaks with an employer.)
- Cliff vesting allows an employee access to 100% of their benefits after five years with the company. However, if one leaves the company before the five-year period, one loses all pension benefits.
- Graded vesting, on the other hand, only entitles an employee to 100% of their benefits after seven years. However, they become vested in their plan (as the name implies) in a gradual manner, rather than at an all-or-nothing date. After three years, employees must be 20% vested in their plan. Each subsequent year entitles them to another 20%, up to 100% at the seven-year mark.
Defined Benefit Plan Payouts
Defined benefit plans are designed to pay beneficiaries over a fixed period. There are, however, several different payout structures.
Single Life Annuity structures make monthly payments to one person. The employee will, therefore, receive the predetermined payments for the rest of their life. Payments then cease when they pass away. Meanwhile, Joint and Survivor Annuities are built for couples. Regular payments will continue as long as one spouse is alive. If one passes away, the other will still receive pension benefits.
A Period Certain Annuity is a hybrid option, providing guaranteed payments for a predetermined number of years, rather than a lifetime-dependent structure. If, for example, the plan has a period certain of 10 years and the plan holder dies five years in, their spouse (or other beneficiary) will receive payments for another five years. This option helps ensures financial security for one’s survivor, without committing to a full J&S annuity structure.
Finally, there is the Lump-Sum Payment. A lump-sum payment plan allows employees to receive the benefit in one single payment, as opposed to monthly. Many defined benefit plans require small benefit accounts to be paid out in a lump sum. Larger plans, on the other hand, do not always permit lump-sum payments, due to the cash drains it can cause, as well as the contradictory nature of a lump-sum payment operating as retirement income.
Retirement Ages and Your Pension Plan
Pension plans are designed relative to the attainment of normal retirement age (NRA), which varies by birth date. According to the Social Security Administration, the NRA for all persons born after 1960 is 67 years of age. Those born prior to 1960 may be subject to different time frames, depending on their year of birth. For the most accurate data, employers and employees should refer to the SSA’s NRA calculator to determine personal NRA dates.
Some phased retirement plans allow companies to retain employees part-time between the ages of 62 and 64 years. These employees can begin receiving reduced benefits while still employed. Alternatively, they can receive their full benefits at the predetermined NRA.
Some defined benefit plans also feature an early retirement option, which comes coupled with an employment period agreement. For example, if an employee has been employed with a company for over 10 years, some plans may allow them to take early retirement between 55 and 64. This scenario would permit them to receive payments in full before their NRA. However, in this scenario the payment amount would be adjusted according to the extended period. The employee will receive a reduced monthly payment, allowing the funds to last longer.
Simplify Pension Benefits Management
Offering workers an employer-sponsored retirement plan can radically improve your workforce culture and reduce employee turnover. Defined benefit plans also offer business owners a solution to fast-track their own financial security for retirement.
Polaris Wealth Advisory Group can simplify your pension plan design and administration responsibilities by existing as a single contact point and plan fiduciary. From initial plan evaluation to ongoing employee education, our expert financial advisory team can help you and your employees reach your goals and achieve financial security. Get in touch with a Polaris team member today to schedule a complimentary and competitive employer-sponsored retirement analysis.
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