[Blog] The Complexities of Managing a DB Plan on Your Own

Jason’s fingers hovered over the keyboard for a moment before he typed: Defined Benefit Plan. He could still hear his friend’s voice from their lunch earlier—enthusiastic, insistent: “It’s a game-changer, Jason. Big savings. Huge tax advantages.”

The words had hung in the air like a promise. Jason’s eyes narrowed as he began researching, scrolling through the pages and muttering under his breath, “Could this really work?”

Jason checked the qualifications for the plan. He met them all. He clicked on a link with steps to set up a plan, read through the instructions, and then faltered. The setup and maintenance were intense. He was expected to calculate a complex formula. And the formula changed each year! How am I supposed to manage this plan on my own?

Many business owners, like Jason, choose a Defined Benefit Plan (DB Plan) for its substantial savings and significant tax perks. A DB Plan often outshines standard retirement options

At first glance, a DB Plan may appear straightforward. You contribute annually, reap tax benefits, and build a substantial retirement fund. However, as Jason quickly discovered, beneath the surface lies a web of complexities that many investors underestimate or overlook.

The Complicated Defined Benefit Plan Formula

For common retirement plans, like a 401(k) or SEP-IRA, we’re accustomed to simplicity. These plans are straightforward: They have clear caps on contributions based on income. They have considerable flexibility in how you manage your investments. A DB Plan, though, is much more complicated.

For starters, a DB Plan requires an actuary—an expert who specializes in running the formulas necessary to maintain the plan. In fact, it’s an IRS requirement to have an actuary involved in the setup and maintenance of a DB Plan. An actuary ensures that the plan remains compliant with IRS regulations. And they ensure contributions are correctly calculated through a complex formula.

The main challenge of a DB Plan lies in the calculation of your annual contributions. Unlike other retirement plans, the contribution amount is not fixed. Instead, it’s determined by a formula that takes into account various factors, including your age, retirement age, predetermined accrual rate, and expected investment returns.

The formula is dynamic. It changes with your business circumstances. Certain factors that affect the formula include:

• Adding employees;
• Losing employees; and,
• Drastic changes in your income.

Finally, investment performance is crucial to the formula. The returns on your plan’s investments must be consistent. Significant deviations from expected returns can disrupt the plan. This can lead to underfunding issues that can jeopardize your retirement goals.

The Risks of Underfunding

A DB Plan is subject to stringent regulatory requirements, like a minimum funding standard. If your plan is underfunded in any given year, then you will have to play catch up. Most business owners, especially those who own small businesses, can’t guarantee how much money they’re going to make each year. Without a consistent income, the pressure to make up for underfunding can create financial strain and anxiety. And it can leave you with far less in retirement savings than you originally planned.

For example, say you set a goal to accumulate $2 million by retirement. However, due to underfunding and mismanagement, you only reach $1 million. Upon retirement, you’re facing a significant shortfall of what you planned. This will impact your financial security, and it can affect your quality of life during retirement.

The Role of Professional Guidance

Engaging a financial advisor who specializes in DB Plans can reduce your anxieties by ensuring all the details are expertly addressed. A specialist will manage the plan on your behalf. They will ensure compliance with regulations and optimize contributions. This allows you to focus on what you do best—running your business. Your primary responsibility will be to keep your advisor informed of the happenings in your business each year. Your advisor will handle the rest. 

Managing a DB Plan on your own is complicated and challenging. However, by leveraging professional expertise, you can confidently pursue your retirement goals without the stress and uncertainty of managing a DB Plan on your own.