Quick answer: A defined benefit plan is a pension plan funded entirely by the business that promises a specific monthly retirement benefit — typically the lesser of 100% of average compensation or $275,000/year (2024 limit). An actuary calculates required annual contributions, which for a 55-year-old owner can exceed $200,000 per year — all fully deductible. It's the most powerful legal tax deferral available to high-income business owners.
How the Contribution Formula Works
Unlike a 401(k), you don't choose how much to contribute — an actuary calculates the annual amount required to fund your promised future benefit, based on your age, income, assumed investment returns, and years until retirement. The older you are and the fewer years until retirement, the higher the required annual contribution. A 58-year-old owner with $400,000 in income and a 5-year horizon might be required to contribute $250,000/year. The IRS caps the annual benefit at the lesser of $275,000 (2024) or 100% of average compensation for the highest 3 consecutive years, but for most business owners the income cap is the binding constraint.
Who Benefits Most from a Defined Benefit Plan
The defined benefit plan is most powerful for older, high-income business owners who are behind on retirement savings and want to shelter a large portion of income in a short window before selling or retiring. It pairs well with a 401(k)/profit sharing plan in a "combo" structure. Ideal candidates: physicians, attorneys, CPAs, consultants, or any professional with net income consistently above $200,000 who is 50 or older and has few or no employees. If you have employees, the plan must cover them at proportional contribution levels — which can make it expensive or impractical.
Key Tradeoffs and Requirements
Defined benefit plans require annual actuarial valuation (cost: $2,000–$5,000/year) and Form 5500 filing. Contributions are mandatory — if the business has a bad year, you still owe the actuarially required contribution (though you can design some flexibility). Terminating the plan is possible but involves excise taxes if assets exceed liabilities. The assets grow tax-deferred and are taxed as ordinary income at distribution. Work with a pension actuary and CPA to design and maintain the plan — this is not a DIY retirement account.
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