Doug’s Blog

Defined Benefit Plan

Posted by:

In one of my quarterly meetings with my tax preparer and consultant John DePasquale – we discussed in detail as to what my options were to have the ability to put more money aside for retirement and potentially get a tax deduction as well.  John came back to me in a few days and said three words that have changed my retirement significantly in that I will be able to retire sooner than originally thought – those words being Defined Benefit Plan.

So I couldn’t help but be skeptical when John told me about a plan aimed at small-business owners in their 50-60’s who have saved not saved enough for retirement but can now afford to put aside a lot of money each year. They can then deduct that money as a business expense, resulting in a significant tax savings.

But I checked with the Internal Revenue Service, and the plan is indeed legitimate.

It is indeed called a defined-benefit plan, much like the one large employers once regularly offered their workers, that guarantees a set monthly payment in retirement. In this case, though, the plan works best for small businesses — those that employ just one or two people.

The I.R.S. allows a maximum annual contribution to the plan of about $255,000 for people in their 50s. (For younger workers, the contribution limit is lower, because the calculation is based on the number of years until retirement. In some cases, the limit is so low that other retirement savings options might be better.) Total holdings in the plan are limited to $2.3 million to $2.4 million, enough to cover the maximum allowed payment in retirement of $200,000 a year.

The Financial Advisers I talked to said the plans were less effective in companies with more employees, particularly older ones, because the owner would be required to make contributions for all of them, and at a high level, since older employees are typically better paid and closer to retirement. (If the additional employees were young and low-paid, the cost of offering the plan to them might be low enough for it to make sense.)

UPSIDE Defined-benefit plans are mainly a way for small-business owners who neglected to save for retirement to catch up. The ideal candidates can put away $100,000 to $150,000 a year for at least 10 years.

Example:

John, a businessman in his late 50s had nothing saved for retirement.  John was independent contractor for a company. His business provides steady, predictable income. He wants to start saving for retirement. He was advised about said a defined-benefit plan in that he could both defer taxes and for saving for retirement. He DBP advisor tells him what minimum and maximum contribution is. He writes the checks directly out of his business checking account. If he makes the minimum amount each year the plan stays in effect. This allows John to save a great deal of money over a short period of time plus reduce his business income tax obligations.  John has been advised that when does retire to roll it in to a IRA thus reducing expenses and giving him more control over withdrawing the money.

DOWNSIDES Again as previously mentioned the primary problem with defined-benefit plans is you must fund at least to a minimum level each year. You also must have an actuary do your actuarial analysis each year. And you must fund the minimum amount, or your plan’s in violation and you have all kinds of problems.

Since the retirement benefit is set, it is the responsibility of the person who created the plan to make sure it is financed to that level. This means regular annual contributions. It also means the owner must be prepared to put in extra money if the plan dips enough in value to be considered in default.

For a company with only one or two employees, that problem is somewhat easier to manage. The plan could be reworked to lower the ultimate benefit if the owner cannot make the minimum payment or an additional payment.

MY CASE is that we started our DBF at the end of last year we were being ready “behind the 8-ball”.  We filed an extension as you can contribute until you file your taxes but this can get you seriously behind.  We just recently hit the minimum contribution and have filed our taxes.  We now plan on trying to hit the maximum for tax year 2017.  Our upfront costs to set up the DBP were approximately $2200 after some negotiation.  We also negotiated our yearly actuary fees that are a yearly cost upfront as well so no surprises, which are a few hundred dollars a year.  We are ecstatic about our DBP as it will allow us to save in a short time period what we believe we need to supplement other retirement assets and retire “on time” + in our particular case, lower our taxes!

0
  Related Articles

Add a Comment