Maximum Total Deductible Contribution to Both Defined Benefit and Profit Sharing/401(k) Plans

Generally, employers that adopt both a defined benefit plan and a defined contribution plan (including a profit sharing plan with or without 401(k) salary deferral contribution features) are able to make the maximum contribution to both plans. However, that’s not always true. In some cases, there is a lower maximum deduction that may be applicable to certain employers on the total combined contribution to both plans.

Closely held businesses often want to adopt and maintain both a defined benefit plan and a defined contribution plan in order to maximize the company’s total deductions and to maximize retirement contributions. Aside from traditional defined benefit plans, fully insured plans and cash balance plans are also types of defined benefit plans. While there are also several types of defined contribution plans, profit sharing plans and/or 401(k) plans are the more popular types.

A defined benefit plan can be designed to provide maximum retirement benefits and a 401(k)/profit sharing plan may allow employees to maximize salary deferral contributions. However, some employers may have defined benefit plans that may not be insured by the Pension Benefit Guaranty Corporation (PBGC). In those cases, the total combined deductible contribution to both a defined benefit plan and a defined contribution plan (including a profit sharing/401(k) plan) may be limited. PBCG insurance may not be available if:

  1. the only employee(s) who will be participating in the plan are only the owner/employees (including the spouses, as may be applicable), or

  1. the employer is a professional service company (e.g., dentists, doctors, lawyers, public accountants, architects, pharmacists, etc.) with no more than 25 employees.

In those cases, the Internal Revenue Code provides that the employer’s aggregate total maximum deductible contribution to a defined benefit plan and a defined contribution plan (including a 401(k)/Profit Sharing plan) may not exceed the greater of:

  1. 31% of the total compensation of all eligible employee(s) in both plans if the contribution to the defined benefit plan is less than 25% of total compensation; or

  1. The sum of the contribution to the defined benefit plan, and the contribution to the defined contribution plan (excluding any employee salary deferral contributions to the 401(k) portion of the plan) not exceeding 6% of the total compensation of all eligible employee(s) if the contribution to the defined benefit plan is more than 25% of the total compensation.

Please note that for qualified plan purposes including in the determination of deductible contributions, the maximum compensation that may be used for any plan participant, may not exceed the maximum amount allowed by the Internal Revenue Service for a given year. For 2013, the maximum annual compensation that may be considered for a plan participant may not exceed $255,000.

The foregoing rule may be illustrated by the following example:

Assume a professional service practice with 3 employees including the owner and spouse:

  • Owner, 52 years old
  • Owner’s Spouse, 42 years old
  • Employee, 40 years old

The employer is considering adopting a profit sharing plan to which employee 401(k) contributions may be made, and a defined benefit fully insured plan with a normal retirement age of 62, designed to provide the maximum retirement benefit primarily for the owner/employee and the maximum deductible contribution. Based on some specific plan designs, as shown below, the annual contribution to the defined benefit fully insured plan for all participants of $262,425 exceeds 25% (i.e., 77.18%) of total compensation. Consequently, the total maximum employer contribution to the profit sharing plan for all participants (consisting of a profit sharing contribution and a 3% safe harbor contribution) is limited to 6%.

Employee

Annual Compensation

Annual Contributions

Fully Insured

412(e)(3) Plan

Profit Sharing/401(k) Plan

Profit Sharing Safe Harbor

Total ER

Contribution

EE 401(k)

Owner $ 255,000 $ 227,941 $ 9,800 $ 7,650 $ 17,450 $ 17,500
Spouse $ 45,000 $ 20,142 $ 313 $ 1,350 $ 1,663 $ 17,500
Employee $ 40,000 $ 14,342 $ 87 $ 1,200 $ 1,287 $ 0
TOTAL $ 340,000 $ 262,425 $ 10,200 $ 10,200 $ 20,400
% of Compensation

77.18%

6%

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