YOUR FINANCIAL FUTURE / What Small Business Owners need to Know about Defined Benefit Plans Part 2

By Roxanne E. Fleszar, CFP, ChFC

April 15th is still a recent memory; are you wondering if you can reduce your tax liability in 2016? If you are a small business owner or a sole practitioner, a defined benefit plan may be just the ticket you are looking for! Defined benefit pension plans are growing for folks like you primarily because you can defer a significant amount of money and receive commensurate tax benefits.

While the contribution limit to a 401K plan in 2015 is $18,000 for individuals under age 50 and $24,000 for those who are older, there is no established maximum contribution to a cash balance defined- benefit plan. Instead the maximum contribution is based on your age and compensation. Therefore an older highly compensated professional such as a dentist, doctor, CPA, attorney or business owner could put away $250,000 a year into a pre-tax cash balance defined benefit account. Interested? Read on.

Defined benefit plans will credit each participant’s account with a set percentage of salary plus a set interest rate applied to the balance. Participants will receive monthly income based upon the formula in retirement. Contributions will be made for all eligible employees; remember that contributions are based upon age and compensation so those that are younger and presumably less highly paid will receive a smaller contribution to their account.

Another benefit of such a plan is simplified administration of the plan. It truly is less complex than a 401(k) plan! The plan must earn a reasonable rate of interest and receive the appropriate amount of funding to meet its obligations.

The plan should be established with the goal that contributions will be made to it for a minimum of 3 years, preferably 5 years. Changes by Congress over the last decade or so have lowered the normal retirement age to 62 and increased the retirement benefit thus allowing individuals to make larger tax-advantaged contributions earlier in one’s career. It is now a terrific pension alternative for individuals above age 40 and even for those age 60 or more who plan to work for more years.

Of course there are some limits on contributions to fund the plan; 100% of compensation, reduced pro rata for less than 10 years of service or $210,000 (2015). The maximum accumulation limit is approximately $2.5 million.

While defined benefit plans must be funded annually, there is some flexibility to the amount of the contribution. The plan administrator will review your compensation and establish the year’s minimum and maximum contribution range. They will perform the actuarial and tax-related tasks to maintain the plan. These costs are quite reasonable, especially for the benefit that they provide.

New defined benefit plan must be established before year end. Assuming tax extensions, the plan can be funded up to 8.5 months after the end of the tax year.

What if the firm or solo practitioner finds their business plan and/or compensation changes? The plan use past compensation to expand the contribution ranges or the contribution amount may be lowered and it may be paired with a 401(k) plan. The plan may be amended or frozen. Last but not least, it may be terminated with the assets rolled into an IRA.

If a defined benefit plan sounds attractive to you, ask your tax and/or your investment professional for more information.

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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