Retire Better: The Hidden Advantage of the Defined Benefit Plan

If you thought that a defined benefit plan is for small businesses, especially solo entrepreneurs, then you got it wrong.

Pension plans are generally associated with large corporations or unionized workplaces, and you think, “How could this possibly apply to me?”

If you are a high-earning, self-employed individual or solo corporate owner and the only employee looking to maximise your retirement contributions while lowering your taxable income, a defined benefit plan can be a game-changing strategy. It offers a powerful way to accelerate your retirement savings far beyond the limits of traditional retirement accounts.

What is a defined benefit plan?

A defined benefit plan is exactly what it sounds like: a retirement plan that promises a specific benefit at retirement.

Unlike a SEP IRA or a solo 401(k), both of which cap annual contributions, a defined benefit plan focuses on your target benefit at retirement. An actuary calculates how much you must contribute each year to reach that goal, often allowing much larger tax-deductible contributions than other plans do.

When should you consider a defined benefit plan?
Setting up a defined benefit plan is complicated and expensive; you should consider this option only if you

Are somewhat close to retirement
Have high and steady business income
Want to contribute more than $70,000 per year, and
Are willing to commit to multiple years of annual contributions

For instance, if you are a consultant ten years away from retirement and you are consistently pulling in high six figures each year, you are looking to fast-track your retirement savings, but some of the popular options are limited in the amount you can contribute pre-tax if this sounds like you, then a defined benefit plan might be a good fit.

The primary advantage of establishing a defined benefit plan is the ability to set aside substantial amounts of cash for retirement and claim larger tax deductions.

For example, a popular alternative to a defined benefit plan is a SEP IRA, which for 2025 has a maximum contribution of $70,000. If you plan on contributing less than that amount per year, then a SEP IRA is the clear winner. However, if you are looking to contribute more, a defined benefit plan may be the solution.

For starters, a defined benefit plan works best for business owners who are close to retirement, as the annual contribution calculation takes into account the time remaining before retirement. The closer to the retirment date, the more you can contribute.

Also, note that if you are further away from retirement, you can make maximum contributions with a SEP IRA. However, advisors recommend waiting until the age of 50 before starting a defined benefit plan.

Moreover, if you want to contribute as much as possible to a defined benefit plan, you need relatively high and consistent income every year. If your annual earnings are not high or consistent enough, you will find it difficult to maximize your tax-deductible contributions.

Lastly, you must have the craving to make a substantial contribution each year. Unlike SEP IRAs, where you can be random about your annual contributions, defined benefit plans have minimum funding requirements.

How much can you contribute?

Though you can contribute a lot, the IRS puts benefit, compensation and plan accumulation impediments in the mix, which are as follows for 2025:

The plan can provide an annual retirement benefit up to the lesser of $280,000 per year or 100 per cent of your highest three consecutive years of average compensation, starting at age 62.
The compensation limit for 2025 is $350,000.
The maximum you can accumulate in your defined benefit plan at the end of 2025 is $3.5 million.

The actuary calculates your annual contribution to ensure that, over time, the plan does not exceed these limits. If plan assets grow faster than expected, the actuary will reduce your contributions to prevent exceeding the IRS accumulation cap.

Keeping that in mind, annual contributions can range from hundreds of thousands to millions of dollars, depending on your current age and desired retirement age. This can be exciting, especially considering the tax savings if you are in the top tax bracket. Say you are earning over $1 million and contributed $300,000 to a defined benefit plan, you would save $111,000 in federal income tax alone.

What’s the catch?

The major drawback of a defined benefit plan is that you must commit to spending money to set it up and maintain it. This is not a ‘set it and forget it’ type of plan. It requires the help of an actuary.

For instance, you first have to establish the plan. This can cost between $1,200 and $2,500. Then you need to hire an actuary who will determine how much you can contribute each year and also file your required reports, like IRS Form 5500-EZ, when your plan assets exceed $250,000. The actuary will likely cost between $1,000 and $4,000 a year.

You can find defined benefit plans and actuarial referrals, and possibly actuarial support, at many brokerages, including:

Charles Schwab
Fidelity
Vanguard
TD Ameritrade
E*Trade by Morgan Stanley
Merril Lynch
LPL Financial
Raymond James

Unlike with a SEP IRA or solo 401(k) plan, you cannot easily access defined benefit plan funds before retirement. Withdrawals must follow the plan’s rules, and early access may involve taxes and penalties.

Also, if you want to receive a lump-sum payout at retirement, you likely need to terminate the plan.

BergerCPAFirst, with over 30+ years of experience, offers comprehensive tax preparation services for individuals and businesses nationwide. Our commitment is to provide personalized attention while ensuring compliance and maximizing tax benefits. If you have any questions or would like to schedule a consultation, please call (201) 587-9200 or send us an inquiry.