Small Company Defined Benefit Plans
You may have heard of a Defined Benefit Plan, but what exactly is it? Well, it's a type of retirement plan where the "benefit" represents the amount of retirement wealth the plan will provide annually at retirement age.
A Defined Benefit Plan is different in many ways from what is known as a Defined Contribution Plan (a 401(k) plan - where the participant "defines" the contribution). The reason that a Defined Benefit Plan is so valuable is that it allows high income earners the largest IRS approved contribution to a qualified retirement plan while saving huge amounts in taxes.
A Defined Benefit Plan is different in many ways from what is known as a Defined Contribution Plan (a 401(k) plan - where the participant "defines" the contribution). The reason that a Defined Benefit Plan is so valuable is that it allows high income earners the largest IRS approved contribution to a qualified retirement plan while saving huge amounts in taxes.
So who is a good candidate for a small company Defined Benefit Plan? The ideal situation would be:
Life happens. College tuition, medical costs, divorce. If your retirement funding isn't where you want it to be, maybe there's an option. Because if you're the owner of a small business that's now generating income that looks somewhat predictable for the foreseeable future, a small business Defined Benefit Plan might be just the answer.
Yes, there is more administration and cost with Defined Benefit Plans than with Solo 401(k) plans and Defined Benefit Plans have to include any employees you may have (Solo 401(k) plans can't generally have employees). But if you need to play catch-up with your retirement funding, you should consider how a Defined Benefit Plan can help you.
Two more items to note: 1) a Defined Benefit Plan will work with most any business entity structure you operate under; Sole Proprietorship, "C" or "S" Corporation and an LLC. 2) a Defined Benefit Plan can even be integrated with a Solo 401(k) plan (if you don't have employees) to give you even more annual contribution flexibility.
Note from this chart how much more you can make in annual tax deductible contributions with a Defined Benefit Plan compared to other types of retirement plans
► A small business owner, age 45-70
► The business owner earns at least $100,000 annually in one of the following ways:
✓ Owns a business with 5 or fewer permanent employees, including the owner
✓ Is Self-employed as primary means of earning a living
✓ Has a second occupation in which client works for himself or herself
✓ Is considered an Independent Contractor rather than an employee
► Business owner wants to contribute more than $50,000 annually to their retirement or a higher percent of income than allowed in a 401(k) plan or SEP-IRA
► Business owner expects to be able to make that contribution for at least three years
► The business owner earns at least $100,000 annually in one of the following ways:
✓ Owns a business with 5 or fewer permanent employees, including the owner
✓ Is Self-employed as primary means of earning a living
✓ Has a second occupation in which client works for himself or herself
✓ Is considered an Independent Contractor rather than an employee
► Business owner wants to contribute more than $50,000 annually to their retirement or a higher percent of income than allowed in a 401(k) plan or SEP-IRA
► Business owner expects to be able to make that contribution for at least three years
Sole proprietor, desires maximum tax deduction
- Annual earnings: $400,000
- Maximum DB + Solo 401(k) contribution for 2008: $167,900
- Contribution to DB Plan: $133,600; Solo 401(k): $34,300
- Annual Tax savings (38% rate): $63,800
- DB accumulation at age 62: $2.2 million (10 years of 5-7% return)
- Annual DB benefit at retirement age 62: $185,000
Thomas, Age 60, Mary, Age 58
Consultants, C-Corp, Married Couple in business together
Consultants, C-Corp, Married Couple in business together
- 5 & 7 years from retirement
- W-2 Income: $460,000 ($230,000 each)
- Total annual DB contribution: $314,000
- $166,000 towards Paul, $148,000 towards Mary's retirement
- Annual combined income tax savings: $119,500
- Accumulation at retirement: Paul - $1.0mm, Mary $1.46mm
Dentist, C-Corp
- Owner's W-2 income: $400,000
- Employee 1: age 28, earning $35,000; Employee 2: age 35, earning $45,000
- 2008 maximum B contribution for owner: $158,000
- DB contribution for Employee 1: $4,400, Employee 2: $8,700
- 92% of total contribution allocated towards Carol
- Annual income tax savings (38% rate) for Mary: $60,300
- Accumulation at retirement at age 62: $1.6mm
Below are three real-world examples of how these small business owners are taking maximum advantage of a Defined Benefit Plan.