While the talk about retirement plans is usually centered on 401(k) plans, the value of a defined benefit plan for those companies that could afford it should not be discounted. Thanks to the generous deductible contribution of the requirements of minimum funding, small business owners can certainly sock away more money than they ever could do with a defined contribution plan.
The problem with these huge deductible contributions, is that there are always some unscrupulous plan providers that exploit the defined benefit plan sponsor’s ability to make large contributions to their own advantage.
Defined benefit plans are huge savings vehicle for retirement, but they should not be used solely as a vehicle to purchase life insurance. I have seen too many defined benefit plan sponsors purchase large life insurance policies where their minimum funding contribution is used solely to pay the premium of a large insurance policy within the plan. The problem? When times go bad and the plan sponsor doesn’t have the financial wherewithal to continue making the contributions, they essentially forfeit the goal of the life insurance policy. A company that didn’t buy a policy or bought a smaller policy is in a better spot as ceasing future accruals isn’t such a calamity as to those that lost their policies.
Life insurance is an attractive tax savings vehicle with a defined benefit plan, but like red meat and wine, it should only be used in moderation. I would recommend avoid setting up a defined benefit plan with the whole purpose of funding life insurance. I would recommending not using a third party administrator (TPA) who also sells life insurance because I believe it’s the ultimate conflict of interest when your plan designs you create as a TPA is used to sell life insurance you’re selling. Let’s face it; there are bigger margins in life insurance than plan administration. Also avoid defined benefit plans that feature special trusts and special trustees as the Internal Revenue Service have found these as possible grounds for plan disqualification.
How to avoid these insurance hucksters? Pick a TPA that is independent from an insurance sales person, make sure your entire annual minimum contribution isn’t fully used to pay the life insurance premiums, and get a second opinion from an ERISA attorney.
Defined benefit plans should be used to save for retirement, not to net an insurance salesman a huge commission.