Defined Benefit Plan vs Defined Contribution Plan

Defined Benefit vs Defined Contribution Plans

Complete Guide for Business Owners

Retirement benefit depends on level of contributions and investment returns.

Retirement benefit predefined. Contributions calculated each year to reach target.

Annual contribution is limited to $77,500 per person.

Annual contribution as high as $250,000+ each.

Contributions are discretionary.

Contribution generally required each year.

Employer contributions are limited to 25% of pay.

Employer contributions NOT limited to 25% of pay.

Assets may be in individual accounts or pooled.

Assets must be pooled.

Administration cost is generally lower, but the maximum deduction is limited.

Administration cost is generally higher, but deductions can be much larger.

Defined Contribution Plan

Defined Benefit Plan

For self-employed professionals and small business owners, choosing the right retirement plan can significantly impact both tax savings and retirement security. Two common options are Defined Benefit Plans and Defined Contribution Plans. Understanding the differences — and how each works for your situation — is critical to maximizing retirement savings and minimizing taxes.

For business owners looking to maximize tax-deductible retirement contributions, a Defined Benefit Plan can often provide significantly higher contribution limits than a Defined Contribution Plan, like a 401(k) Plan. Your allowable contribution depends on factors such as age and income level. Use our Defined Benefit Plan calculator to see how much you could contribute!

Defined Benefit Plan vs. Defined Contribution Plan: Key Takeaway

Key Differences at a Glance

Why Choose a Defined Benefit Plan?


A Defined Benefit Plan is ideal for high-income, owner-only businesses. Key advantages include:

  • Maximum contributions: $100,000 to $250,000+ annually.
  • Lower payroll taxes: Contributions may exceed 25% of compensation, reducing payroll taxes compared with Defined Contribution Plans.
  • Three-year averaging: Defined Benefit Plan contributions are calculated using the highest consecutive 3-year average of all business compensation, not just the current year's compensation. This allows for larger contributions relative to W-2 income and helps reduce payroll taxes compared with Defined Contribution Plans.
  • Adding a spouse increases deductions: Employing your spouse increases, and may even double, the maximum contribution.
  • Combine with a 401(k) Plan: Further increase retirement savings and tax deductions by pairing with a 401(k) Plan.

Pros: Very high contributions, potentially reduced payroll taxes, can combine with a 401(k) Plan.
Cons: Annual contributions are required within a calculated range, higher administration costs.


Defined Benefit Plan examples:

Example 1a
John, age 55, started an S Corporation four years ago and has paid himself $250,000 in W-2 wages. By establishing a Defined Benefit Plan, he can accumulate $3,360,000 over 10 years, building a substantial retirement nest egg while reducing taxable income. Assuming an average investment return of 5%, that works out to an annual contribution of just over $250,000, or 100% of W-2.

Example 1b
After talking with his CPA, John lowers his W-2 to $100,000 per year. His Defined Benefit contribution remains unchanged because contributions are based on the prior 3-year average. This reduction in W-2 wages significantly lowers John's payroll taxes for the next several years.

Example 1c
John adds his 52-year-old spouse, Anne, as a plan participant and pays her $100,000 per year in W-2 wages. They can accumulate an additional $1,280,000, for a total of $4,640,000, over 10 years. Assuming a 5% investment return, this allows an extra $100,000 per year, for a total of $350,000 per year.

Example 1d:
By adding a 401(k) Plan, John and Anne contribute an extra $74,000 per year ($62,000 employee deferrals + $12,000 employer contributions), further maximizing tax savings.

Defined Contribution Plans: Flexible, but Limited

Common Defined Contribution Plans include 401(k) Plans and SEP-IRAs:

  • 401(k) Plan: Allows up to $77,500 in annual contributions with catch-up contribution assuming a current year's W-2 of at least $186,000.
  • SEP-IRA: Maximum $70,000 annual contribution if the current W-2 is $280,000 or more.

Pros: Contribution are discretionary, no-cost or low-cost administration.
Cons: Lower contribution limit, higher payroll tax for a given W-2 wage.

Choosing the Right Plan

Choose a Defined Benefit Plan if:
  • Defined Contribution Plan limits are insufficient.
  • You want high retirement contributions relative to W-2 wages.
  • You can make annual contributions or predict profitability in advance.
  • In general, you are 35 years or older.

Choose a Defined Contribution Plan if:
  • You do not want to exceed Defined Contribution Plan annual limits.
  • You are younger than 35 years old.
  • Your income is irregular and hard to predict in advance.

Tip: Many high-income business owners combine a Defined Benefit Plan with a 401(k) Plan for maximum contributions and tax savings.


FAQs: Everything You Need to Know

How much can I contribute to a Defined Benefit Plan?
Contributions are actuarially calculated based on age, income, and retirement goals — often $100k to $250K or more.

Do I have to cover employees?
Owner-only businesses avoid nondiscrimination requirements, so 100% of contributions go to the owner. Businesses with eligible employees must comply with IRS rules.

Can I combine a Defined Benefit Plan with a 401(k) Plan?
Yes. Pairing a Defined Benefit Plan with a 401(k) Plan can maximize contributions and tax deductions. However, the 401(k) employer contribution limit is reduced from 25%, to 6%, of plan compensation.

How do Defined Benefit Plans reduce taxes?
  • Large tax deductions for plan contributions.
  • Contribution may restore phased-out itemized and Section 199A deductions as well as tax credits.
  • May reduce payroll taxes if wages structured efficiently.
  • Contributions grow tax-deferred.
  • At plan termination, assets can be rolled over to an IRA to continue tax deferral.

Are there contribution limits?
Yes, but the annual contribution and the overall lifetime limit is determined actuarially. Also, unlike SEP- IRAs and 401(k) Plans, Defined Benefit Plans are not subject to the 25% of compensation limit. 

Can I roll over Defined Benefit Plan funds at retirement?
Yes. Lump-sum distributions can be rolled into an IRA, SEP-IRA, or 401(k) Plan.

Which plan is better for someone starting late?
Defined Beneit Plans allow higher contributions well in excess of the catch-up contributions in 401(k) Plans, which is ideal for a business owenr looking to maximize savings quickly.


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