The 2007 subprime mortgage meltdown has left millions of older workers scrambling to find ways to shore up their retirement plan balances. Employers are likewise anxious to ensure that their pre-retirees receive the full amount of pension income that they are entitled to. Fortunately, employers can offer a new type of retirement plan to employees. This plan, known as a DB(k) plan, offers a unique combination of a defined-benefit plus voluntary employee contributions. This article examines the provisions of this plan and how it can benefit workers of small businesses.

Retirement Savings Shortfall
After World War II, employers commonly provided guaranteed pensions to the majority of their employees in the form of defined-benefit plans. However, inflation and rising administrative costs forced many firms to switch to defined-contribution plans that were funded by employee contributions. But the fallout from the meltdowns at Enron and Worldcom combined with the decline in the stock market has cast doubt upon the effectiveness of traditional defined-contribution plans such as 401(k) and 403(b) plans. Although these plans offer greater freedom of investment choice to employees, their voluntary nature and non-guaranteed returns have left a large percentage of workers without a retirement nest egg.

Defined-benefit plans provide a guaranteed income stream, but their cost and complexity are generally prohibitive for all but the largest and most profitable employers. Spurred by public demand for a solution, Congress sought to begin addressing this issue with the Pension Protection Act of 2006, which resulted in many changes and improvements to retirement plans in America. This legislation also contains provisions for a new type of hybrid retirement plan, known as the DB(k) plan.

How It Works
DB(k) plans essentially layer a guaranteed stream of income on top of voluntary employee contributions. These plans contain three main features:

  • A guaranteed pension benefit equal to 1% of an employee's final average pay for each year of service up to 20 years.
  • Automatic enrollment for all employees in the defined-contribution portion of the plan. The contribution level is initially set at 4% of the employee's pay, but employees have the option of raising, lowering or canceling this amount.
  • Matching employer contributions of at least 50% of employee deferrals, up to 2% of employee pay.

DB(k) plans are much simpler administratively than any combination of conventional 401(k) or defined-benefit plans in many respects. The top-heavy rules that other types of qualified plans are required to adhere to do not apply to DB(k) plans. Only one plan document and Form 5500 are required to establish this plan. The main benefit provided by this plan is obvious: DB(k) plans can provide a unique combination of guaranteed income with the possibility of market gains for employees, fueled by employer matching contributions. Essentially, this system will combine personal investment control with the safety of traditional pensions. The following example illustrates a possible scenario for a hypothetical employee.

Yuriy Barer begins working for ABC Company in 2010 and retires from there 20 years later. His final average salary is $65,000 per year. He contributed 5% of his salary to his DB(k) plan during his tenure with the company, and his contribution plan balance now stands at just under $104,000¹. However, he will also receive a guaranteed payout of $13,000 per year² from the defined benefit portion of the plan in addition to his Social Security.

Who Can Use a DB(k) Plan?
Under current legislation, only employers with less than 500 employees will be eligible to open a DB (k) Plan. As it becomes more common, it is possible that the 500 employee limit will be raised. But despite their hybrid status, DB (k) plans still require a significant funding commitment from the employer to cover the defined benefit element of the plan. Therefore these plans are probably most appropriate for employers with high profit margins and large cash reserves.

The Bottom Line
Although they have some limitations, DB(k) plans may provide a solution to the retirement funding dilemma faced by many employers. These plans allow workers to retain the opportunity for market growth through their contributions in addition to providing a guaranteed stream of income for life. Employers that wish to learn more about these plans should contact the IRS or their benefits consultant.

[1] This balance is based on the assumption of 5% of $65,000 being contributed each year for 20 years, with a 50% employer match each year. This comes to $3,250 of salary deferral plus a 50% match for a total joint contribution of $4,875 per year. Assuming 8% growth for 20 years, the final balance comes to $103,929.15
[2] The guaranteed payout is based on a 1% multiple of Barer's final average salary. $65,000 X 1% X 20 = $13,000.

Related Articles
  1. Taxes

    New Retirement Plan Limits For 2011

    New changes to the law can have a huge impact on your nest egg.
  2. Options & Futures

    Which Retirement Plan Is Best?

    We'll show you how to choose between Roth IRAs, Traditional IRAs and 401(k)s.
  3. Entrepreneurship

    401(k) Plans For The Small Business Owner

    If you own a business, this may be the plan for you! Find out about its benefits and eligibility requirements.
  4. Savings

    6 Ways to Save Money on Back-to-School Stuff

    Those school-supply lists just keep getting longer each year. Here's how to shop smart.
  5. Retirement

    The World's Most Luxurious Retirement Destinations

    If money is no object (or if you would just like to dream), these five spots are the crème de la crème.
  6. Professionals

    Social Security 'Start, Stop, Start' Explained

    The start, stop, start Social Security strategy is complicated. Here's what retirees considering it need to consider.
  7. Retirement

    Strategies for a Worry-Free Retirement

    Worried about retirement? Here are several strategies to greatly reduce the chance your nest egg will end up depleted.
  8. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  9. Professionals

    How to Build a Financial Plan for Gen X, Y Clients

    Retirement is creeping closer for clients in their 30s and 40s. It's a great segment for financial advisors to tap to build long-term client relationships.
  10. Professionals

    Don't Let Your Portfolio Be Trump'd by Illiquidity

    A look at Donald Trump's statement of finances and the biggest lesson every investor can learn.
  1. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  2. Backdoor Roth IRA

    A method that taxpayers can use to place retirement savings in ...
  3. Linked Transfer Account

    Accounts held by an individual at a financial institution that ...
  4. Current Service Benefit

    The amount of pension benefit accrued by an employee who had ...
  5. Benefits Payable Exclusion

    An insurance policy exclusion that removes the insurer’s responsibility ...
  6. Self Invested Personal Pension ...

    A tax-efficient retirement savings account available in Great ...
  1. What is the difference between a DB(k) plan and a defined benefit plan?

    A defined-benefit plan is an employer-sponsored retirement pension in which a company pays a retired worker a steady income ... Read Full Answer >>
  2. What is the difference between a DB(k) plan and a 401(k)?

    A DB(k) plan is a hybrid qualified retirement plan that offers a 401(k) account with defined-benefit plan guarantees. While ... Read Full Answer >>
  3. How are DB(k) plans set up?

    Setting up a DB(k) plan is not much different from establishing any other qualified retirement plan. In fact, in some ways, ... Read Full Answer >>
  4. Can my IRA be used for college tuition?

    You can use your IRA to pay for college tuition even before you reach retirement age. In fact, your retirement savings can ... Read Full Answer >>
  5. Why are IRA, Roth IRAs and 401(k) contributions limited?

    Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy ... Read Full Answer >>
  6. How do you calculate penalties on an IRA or Roth IRA early withdrawal?

    With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!