Step by step guide to set up a defined benefit plan

1. Contact an actuary or a pension consulting firm (like us)

At first, a calculation needs to be performed about how much you can actually contribute to a defined benefit plan. Unlike 401(k) and profit-sharing plans, contributions to a defined benefit plan vary from person to person. They are typically based on the age of the individual and the compensation history. You can calculate an estimate using our online defined benefit calculator. A final calculation needs to be performed by an actuary though. Feel free to email us at info@pensiondeductions.com for quick assistance.

2. Talk to your CPA

Once you have an initial estimate from the contributions, you will need to collaborate with your CPA to ensure that you have sufficient cash flow to contribute to the defined benefit plan.

For example, your actuary may calculate that you can contribute up to $200,000 in the defined benefit plan in the first year. However, you might want a lower contribution amount and your actuary needs to be informed of that. Once you, the actuary and your CPA agree on a contribution amount, you are all set to go ahead with the next steps,

3. Draft the Plan Document for the defined benefit plan
Once the amount has been decided between you and your CPA, the actuary will need to draft the plan document for you. You will need to provide the legal name of the company, the EIN, address and other details.

Every defined benefit plan requires a plan document that will list all assumptions of the pension plan and ensure compliance with all IRS rules and regulations. This document has to be drafted by an actuary before you can set up the investment accounts for the plan.

A new TIN may also need to be registered for the pension plan as it is a distinct legal entity. The actuary will customize a plan document based on the contributions you need. Make sure your actuary provides you a plan document that is pre-approved by the IRS so you don’t need to go through the hassle yourself. You can read more about a pension plan document here.

4. Set up the defined benefit plan investment accounts
After the plan document has been drafted, you are all set to open the investment account for the plan. You should reach out to your financial advisor or a broker to set up the accounts. Make sure you tell them to open a ‘qualified account’ so that the investment gains are not taxed at source.

You can start making contributions to the plan as and when free cash flow is available once the investment accounts are open. For the first year, the contribution will be what was decided between you and the actuary. The actuary will calculate a range for each subsequent year, along with a recommended contribution amount. You are required to contribute within the range to avoid over funding or under funding the plan. The deposits can be made until you file the tax returns for your business.

5. File with the IRS
All qualified plans are required to file annual returns with the IRS. Note that these returns are different from the company tax returns and your personal tax returns. Also note that the CPA or financial advisor cannot file these returns since these are required to be certified by an actuary.

The actuary will fill up a form called the Form 5500 SF and certify another form called the Schedule SB. You will need to sign the form as the plan sponsor and the actuary will file it electronically. The penalties for not filing these forms run into hundreds of dollars and the pension plan could end up getting disqualified.

If you are a self-employed individual and interested in exploring the idea of a defined benefit plan for yourself feel free to give us a call.