What is a ‘DB(k) Plan’
A DB(k) plan is a hybrid retirement plan that combines some of the characteristics of a defined contribution 401(k) plan with those of a defined benefit (DB) plan. Funds can be voluntarily contributed to the DB(k) plan just as they can with a 401(k) plan, with the employer retaining the option to match the funds up to a certain percentage. Upon retirement, the employer will also pay the employee a small percentage of his or her salary, which is similar to a traditional pension.
The DB(k) Plan has the official name of the Eligible Combined Plan and was created by Congress as part of the Pension Protection Act of 2006 under Section 414(x) of the Internal Revenue Code.
BREAKING DOWN ‘DB(k) Plan’
The DB(k) plan was initially designed to provide small businesses especially, defined as businesses with at least two employees but less than 400, with a way to attract employees, since many investors worry that their entire savings could be wiped out in a down market. Retaining the pension characteristic means that the retiree will still have a source of income, regardless of the performance of the 401(k) portion of the plan. Because the DB(k) Plan combines both a defined benefit component and a 401(k) component, there are some specifications for each category.
Defined Benefit Component:
- The employee is required to receive at least 1 percent of pay for each year of service, but the total amount cannot exceed 20 years.
- Benefits are vested after 30 years of services.
- There must be an auto-enrollment provision with a 4% contribution rate unless the employee elects to reduce this rate or opt-out.
- The employer must match 50% of the employee’s 401(k) contributions, up to 4% of compensation, or a 2% maximum match.
- Employees must be fully vested in the matching contribution when made.
Limitations of the DB(k) Plan
Although the DB(k) Plan sounds like a good idea in theory, its practical application has faced some challenges. Since being signed into law on January 1, 2010, DB(k) plans have actually been slow to grow. DB(k) plans lack of popularity may be due to the strict IRS application requirements for the plan’s designation. For instance, in order to set up a DB(k) Plan, an employer is required to file quite a bit of paperwork, including two separate Form 5300s for each component of the plan, which also means paying two fees for each separate component within the account. The accounts are also too costly for many small business employers to run, since they essentially double the amount of work required for one retirement plan, as each plan requires separate administration.