Help me understand defined benefit plans

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ERguy101
Posts: 144
Joined: Sat Jul 04, 2015 11:09 am

Help me understand defined benefit plans

Post by ERguy101 » Wed Jul 29, 2015 2:50 pm

Hello there-

I met with a fee based financial planner that I've been considering using. baacially went over different savings vehicles and how much I can sock away.

They recommended a defined benefit plan (in addition to 401k, HSA, back door Roth, etc.) I'm an ER doc, and they said the defined benefit for docs is 2.6 million, and my yearly contribution would be $90,000. I don't understand exactly what this means.

Like, I understand a company (July, Benetech, etc) runs the plan, and your investment company (Fidelity, Charles Schwab) can host it. But I don't understand much more. Questions:

1. Let's say I host it at Fidelity. Would I just log in my fidelity account and it would appear there, and I could choose to invest however I want (example, a three fund lazy portfolio)?

2. What is the "defined benefit"? Is it the 2.6 million? And what does that mean? Does that mean when I reach 2.6 million in the account I can withdraw it? Or do I just hit 2.6 million and then try to not go over it, and at age of retirement I can pull the money out?

3. This isn't some kind of annuity, right? Like I don't hit 2.6 million then it pays me a pension.

My understanding now is that it's basically like a 401k, except I have a mandatory minimum contribution. I can invest however I want within the plan. I guess I don't understand what happens from there. What's the end game of the plan?

I promise I have googled, and I've even watched some YouTube videos trying to explain it. I'm hoping one of my fellow bogle heads can explain it to me like I'm five.

Much thanks

furwut
Posts: 1474
Joined: Tue Jun 05, 2012 8:54 pm

Re: Help me understand defined benefit plans

Post by furwut » Wed Jul 29, 2015 3:20 pm

If you haven't already I recommend searching this blog - The White Coat Investor.

Because of their high incomes and the perception they lack time to deal with things outside of work many doctors are pitched very "interesting" investment products. I think you would need to post a specific link to this plan if someone here is going to attempt to decode what it really is.

It could be some Life Insurance / Annuity hybrid. Those things are not usually looked upon with favor here.

EDIT
Could it be a Cash Balance plan your advisor is referring to?
Cash Balance Plans- Another Retirement Plan for Professionals
Last edited by furwut on Wed Jul 29, 2015 9:18 pm, edited 2 times in total.

bsteiner
Posts: 4110
Joined: Sat Oct 20, 2012 9:39 pm
Location: NYC/NJ/FL

Re: Help me understand defined benefit plans

Post by bsteiner » Wed Jul 29, 2015 3:25 pm

There are two basic types of retirement plans, defined benefit and defined contribution.

In a defined contribution plan, you have an account. Your or your employer put in money. You get whatever it grows to. The employer doesn't promise what it will grow to. Examples are profit-sharing plans, 401(k) plans, IRAs.

In a defined benefit plan, you don't have an account. Rather, you're entitled to a monthly pension based on your age, your earnings, and how many years of service you have. An actuary tells the employer how much to put in each year so that the plan will be expected to have enough money to pay the benefits. If they assets don't grow as much as expected, the employer may have to put in more money. In a small company (or a 1-person company), most of the time the plan never pays out the monthly benefits, but rather the employer terminates the plan and pays the employees the value of their benefits in a lump sum. In some plans, retiring employees have the option to take the value of their benefits in a lump sum. In some plans, there's no lump sum option.

Older owners sometimes create defined benefit plans because they can fund their benefits over a relatively short period of time.

An actuary can run the numbers to illustrate how it would work in a given case.

The plan can invest its assets however it wants. The plan need not invest in life insurance or annuities.

dhodson
Posts: 4117
Joined: Mon May 24, 2010 3:03 pm

Re: Help me understand defined benefit plans

Post by dhodson » Wed Jul 29, 2015 6:13 pm

Be sure to avoid plans with insurance products called 412i or 412e plans. The contribution is more bc you are paying more for the same benefit.

These are best when older bc they are expensive to maintain.

adamthesmythe
Posts: 2841
Joined: Mon Sep 22, 2014 4:47 pm

Re: Help me understand defined benefit plans

Post by adamthesmythe » Fri May 10, 2019 10:26 am

I am not a doctor (or, at least, not that kind).

But. I once had a broker recommend some complicated product. I balked, and he said that just because it's hard to understand doesn't mean it's a bad idea.

I thought about it and decided that it WAS a bad idea if I didn't understand it.

So- require that he explain the whole thing, in sufficient detail and allowing plenty of time for you to ask questions, before you even think of investing.

And- although it's not directed at me- I have read some of the white coat investor website. It looks like it would be pretty valuable for MDs who 1) don't have any expertise in investing 2) don't have time to do a lot of research and 3) are a target-rich environment for salesmen.

SovereignInvestor
Posts: 351
Joined: Mon Aug 20, 2018 4:41 pm

Re: Help me understand defined benefit plans

Post by SovereignInvestor » Fri May 10, 2019 10:43 am

I think the 90K contribution exceeds IRS levels that would be tax deferred for qualified plans. Isn't the limit around 50K or something?

latesaver
Posts: 158
Joined: Thu Aug 03, 2017 3:35 pm

Re: Help me understand defined benefit plans

Post by latesaver » Thu Jul 11, 2019 2:56 pm

bsteiner wrote:
Wed Jul 29, 2015 3:25 pm
There are two basic types of retirement plans, defined benefit and defined contribution.

In a defined contribution plan, you have an account. Your or your employer put in money. You get whatever it grows to. The employer doesn't promise what it will grow to. Examples are profit-sharing plans, 401(k) plans, IRAs.

In a defined benefit plan, you don't have an account. Rather, you're entitled to a monthly pension based on your age, your earnings, and how many years of service you have. An actuary tells the employer how much to put in each year so that the plan will be expected to have enough money to pay the benefits. If they assets don't grow as much as expected, the employer may have to put in more money. In a small company (or a 1-person company), most of the time the plan never pays out the monthly benefits, but rather the employer terminates the plan and pays the employees the value of their benefits in a lump sum. In some plans, retiring employees have the option to take the value of their benefits in a lump sum. In some plans, there's no lump sum option.

Older owners sometimes create defined benefit plans because they can fund their benefits over a relatively short period of time.

An actuary can run the numbers to illustrate how it would work in a given case.

The plan can invest its assets however it wants. The plan need not invest in life insurance or annuities.
Thanks for the useful information. It sounds like I could set up a DBP and if i lose my job in 5 years, i can take out in a lump sum what i have put in, plus earnings.

I assume contributions to a DBP are tax deferred? Also, is this something that can be stacked on top of today's $56K limit into a 401K?

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