Special Types of Plans

There are three types of specialized defined benefit plans that deserve special comments.
 

Floor Offset Plans

A floor offset plan is the defined benefit part of pair of plans whose benefits are coordinated. The other plan is a defined contribution plan (usually a profit sharing plan, sometimes with a 401(k) feature). The floor offset plan provides a minimum guaranteed benefit (or “floor” benefit) from both plans combined. A total benefit based on compensation and service is described in the floor offset plan that is then reduced (or “offset”) by a benefit that is equivalent to the account accumulated as a result of employer contributions to the defined contribution plan. After this reduction, the floor offset plan pays what is left and the total benefit from both plans adds back up to the total benefit described in the floor offset plan.

In some cases the benefit equivalent to the defined contribution account is larger than the minimum benefit guaranteed. In this case no benefit is paid by the floor offset plan, but the total benefit (in the form of the defined contribution account) is equivalent to more than this minimum.

In many cases floor offset plans can be designed so that only the business owner and other favored employees receive any benefit from the floor offset plan. This happens because the defined contribution account fully offsets the minimum benefit for everyone else and the plans are combined to pass non-discrimination requirements of the Internal Revenue Code. In order for this to work, the non-favored employees must be, in general, younger than the owner and other favored employees and the non-favored employees must receive a minimum contribution to the defined contribution (generally between 5% and 7% of pay).

Because the floor offset plan is a defined benefit plan and is subject to defined benefit plan limits on benefits, it can provide much larger benefits and annual deductible contributions than a defined contribution plan alone for an older business owner.

A cash balance plan is a defined benefit plan that looks like a defined contribution plan. The benefit in a cash balance plan grows like an account in a defined contribution plan – each year an employer contribution (the contribution credit) is added to a participant’s account balance and the account balance grows with interest (the interest credit). The interest credit isn’t tied to the actual investment return for the plan; it is specified in the plan document. The account balance never loses value so the investment risk and reward are absorbed by the employer, not the participant.

Because a cash balance plan is a defined benefit plan, the contribution for a participant (the pay credit) can be substantially larger than the maximum contribution to a defined contribution plan – depending upon the age of the participant as much as three or four times larger. A cash balance plan can be designed so that, unlike a traditional defined benefit plan, key employees or business partners with the same pay and service receive the same contribution and benefit payout from the plan regardless of differences in their ages.

Fully Insured Plans

These plans used to be known as 412(i) plans. In these plans all contributions are invested in life insurance and/or annuity contracts. The annual contribution is whatever is required under these contracts to guarantee the retirement benefit promised by the plan. At any time before retirement, the "accrued benefit" is the cash value of the underlying contracts.  Many of the more complex factors for determining the required contribution or the value of benefits do not apply to these plans. There are times when a fully insured plan may be more suitable than a traditional defined benefit plan.