Defined Benefit Plan Lifetime Limit. How Much Can Be Paid Out?

This article has been updated for 2024.

How much is the lifetime limit for a Defined Benefit Plan? Many business owners, financial advisors, and CPAs ask us this question.

Before we go any further, let’s define what we mean by a lifetime limit. Simply put, it is the maximum lump sum distribution that can be paid out of a Defined Benefit Plan. This limit takes into account both employer contributions and investment earnings.

So, what is the lifetime limit? The answer depends on several factors, including:

• Age at payout
• Length of time in the Plan
• Years of service granted
• Level of Plan compensation
• Applicable interest rates and mortality table at time of payout

 
In fact, Section 415 of the Internal Revenue Code and the accompanying regulations outline how the lifetime limit is to be calculated. If a payout exceeds the allowable limit, the excess is subject to a steep excise tax. 

Lifetime Limit Depends on Payout Age

The lifetime limit for a Defined Benefit Plan is a function of age at payout. The table below shows the maximum limits for selected ages.

Age	Limit
Age 35	$0.9 million
Age 45	$1.5 million
Age 55	$2.5 million
Age 62	$3.5 million
Age 65	$3.3 million
Age 70	$3.6 million

 
As you can see, the limit is reduced for payment before age 62. This reduction accounts for the longer period of tax deferral when payout occurs at younger ages.

For example, upon termination, a Plan participant may roll over their Defined Benefit lump sum to an IRA. By rolling over their distribution, tax deferral continues until it is distributed from the IRA. As you can imagine, the value of this tax deferral is much higher for a 35-year-old than it is for a 62-year-old. Simply put, the 35-year-old receives an additional 27 years of potential tax deferral. The reduction in the lifetime limit for payout before age 62 reflects that a $900,000 payout at age 35 may reasonably grow to $3.5 million at age 62.
 

Defined Benefit Lifetime Limit Prorated for Service

The lifetime limit phases in over a 10-year period. For this purpose, years are based on how long the Participant is in the Plan. This type of service is called participation service. If the Participant terminates with less than 10 years of participation service, the limit is reduced on a pro-rata basis.

As an example, suppose a business owner adopts a Defined Benefit Plan effective at the beginning of 2023. After 5 years, the owner terminates the Plan. Because the Plan existed for fewer than 10 years, the lifetime limit is reduced on a pro-rata basis. In this instance, the adjusted lifetime limit would be only 5/10, or 50%, of the full lifetime limit.
 

Lifetime Limit Adjusted for Compensation

In addition to being adjusted for participation service, the lifetime limit may be adjusted for compensation. Specifically, if the business owner’s compensation is too low, the lifetime limit may be reduced.

Without going into a lot of detail, the adjustment for compensation is based on a 3-year average of compensation. It also phases in over 10 years (using a different definition of service than participation service). Further detail regarding the adjustment for compensation was provided previously in the article regarding annual contribution limits.

In summary, to receive the full lifetime limit, a business owner may need to increase their compensation. If their objective is to receive the full lifetime limit, your actuary can calculate the level of compensation required.
 

Applicable Interest Rates and Mortality Tables

Interest rates and the mortality table prescribed by the IRS at the time of payout will impact the lifetime limit. In general, higher interest rates and lower expected longevity result in a lower limit. Conversely, lower interest rates and higher expected longevity result in a higher limit.
 

Spousal Employees Get Their Own Lifetime Limit

If a business owner’s spouse also is an employee of the business, there is a potential to double the “household lifetime limit”.

The spouse’s limit is adjusted, just like the owner’s limit, for age, service, and compensation.
 

401(k) Plans Increase Tax Deduction

A 401(k) Plan in conjunction with the Defined Benefit Plan further increases the deduction. Paring a 401(k) Plan with a Defined Benefit Plan is called a DB/DC Combo Plan.

In general, someone who is age 50 or older can defer an additional $30,500 in the 401(k) Plan. What’s more, the employer also may be able to provide an additional contribution as a Profit Sharing allocation. Spousal employees with sufficient earned income can potentially double the 401(k) deduction similar to the Defined Benefit deduction.
 

A Second Defined Benefit Plan Lifetime Limit

Another common question is: Can I get a second lifetime limit? The answer depends on the situation, but, in the right circumstances, the answer is “Yes”!

A common way a second lifetime limit may be available is when someone is involved in two businesses. In general, they either must be an employee or have a minority ownership interest in one or both of the businesses. This situation often arises when a side business exists.

For example, suppose a physician owns 10% of a medical practice. As a partner in the practice, the physician receives a Defined Benefit that is intended to provide the lifetime limit at payout. In addition, the physician also has an unrelated side business doing public speaking where substantial income is earned. In a situation like this, the physician may be able to adopt a Defined Benefit Plan in the public speaking business. Depending on the factors discussed above, he or she can then fund towards an additional Defined Benefit payout. The details are important, so it’s important you check with your TPA/actuary to ensure a second lifetime limit is possible.
 

In Summary

As you can see, a Defined Benefit Plan provides an excellent opportunity to quickly fund your retirement. Understanding the lifetime limit will help you better see the possibilities for your business or practice.