YOUR FINANCIAL FUTURE / What Small Business Owners Need to Know about Defined Benefit Plans

By Roxanne E. Fleszar, CFP, ChFC

The 2015 tax deadline has passed by and if you are a small business owner or a self-employed professional, you may be wondering if how to reduce your tax burden by maximizing contributions to your retirement savings plan in 2016. Have you ever contemplated establishing a defined benefit plan? Yes, one of those plans that was common years ago from large private employers like IBM, GM and AT & T that accrue a significant benefit that can pay you monthly income for life. If you thought today that a defined benefit plan wasn’t for you, read on.

Defined benefit plans have largely been replaced by defined contribution plans; 401(k) plans are common at all sizes of firms, while SIMPLE IRA and SEP IRA plans predominate at smallest of firms. The defined benefit (DB) plan has made resurgence in the small and professional business market. Doctors, dentists, CPA’s and consultants over the age of 40 are establishing them to provide them with the ability to quickly accumulate significant wealth and huge tax deferrals. Happily, today’s DB plans are much easier to administer than in the past.

The motivating factor for many business owners to establish a DB plan is to save taxes; the plan provides the highest IRS-approved deductible qualified plan contribution. In addition, while the plan is a “defined benefit” plan and it can be designed to pay you and income for life, at retirement or plan termination, the assets may be rolled into an IRA which will allow them to grow on a tax-deferred basis until withdrawn.

Many folks both worked very hard at building a business and didn’t fund their retirement, or they left a career in their 40’s or 50’s and started a new venture. If they plan or working a minimum of 3 to 5 years and have lots of disposable income, a DB plan can benefit them tremendously.

Let’s take an example of Tom and Nancy who own a successful IT consulting firm and each earn $260,000 in W-2 income annually. While raising a family, they didn’t save much for their retirement. Now as they approach 60, they want to save enough to retain their current lifestyle. They would love to retire in five years.

Tom and Nancy discover that by opening a DB plan, they could contribute as much as $426,000 to their plan and defer $162,000 in taxes. In five years their nest egg could grow to $2.4 million, assuring them of meeting their retirement goals.

Of course, there are factors to look at prior to establishing a DB plan. One is to be sure that you are comfortable contributing a significant amount of income to the plan for a minimum of 3 years. In addition, you need to take into account the age, income and years of service of all employees. Firms with younger employees and older owners find the plan most attractive.

Contributions will be made to all eligible plan participants within a certain range each year. Typically plan owners contribute and deduct over $100,000 annually to their own accounts or two to three times more than they can contribute to a 401(k), SIMPLE IRA or SEP-IRA plan!

Contact your tax or investment professional now if you want to explore whether a DB plan can work for you.

Roxanne E. Fleszar, CFP, ChFC is President of Financial Resources Management Corp, a registered investment advisory firm with offices in Key West, Boston and Naples.

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