Is a Personal Defined Benefit Plan (aka Cash Balance Pension Plan) your key to catching up for retirement? How to slash your tax bill with a personal pension. Tax Deductions and more money for retirement seem like a smart business move. Why aren’t more people who are self-employed setting up Personal Defined Benefit Pension Plans? Keep reading to find out how the Defined Benefit Plan is the best tax planning tool for Small Business Owners to minimize taxes owed each year. This tax planning financial advisor doesn’t want you to pay more taxes than you are legally obligated to pay.
How High-Income Small Business Owners Can Catch Up on Retirement
Tax-Deferred Retirement Plan for High-Earning Small Business Owners Wish you had a personal pension to help see you through your retirement? Today, small business owners may be able to create their own with a Defined Benefit Plan. Even if you are just a few years away from retirement, these plans may deserve a look at how a Defined Benefit Plan can help the self-employed pay fewer taxes.
You can potentially contribute several hundred thousand dollars pre-tax to a Defined Benefit Pension Plan.
By David Rae Certified Financial Planner™, Accredited Investment Fiduciary™
Financial Planner LA David Rae Helps Small Business Owner Find the Right Personal Defined Benefit Plan
Hey there, big-earning small business owner! As your marathon of working career edges ever closer to the finish line of financial independence and/or retirement, you may be looking for a few more ways to superfund your nest egg. Or you may need to help neutralize the negative effects tax drag is wreaking on your ever-increasing income as an ultra-successful entrepreneurial business maven. Sure, having a high income is a great problem to have. But by no means does it automatically ensure an easy ride financially. Nor does it mean you are on the path to financial independence. Consequently, tax-deferred strategies via self-funded pension plans may offer some real value and give your retirement readiness a nice big boost.
Tax savings are often the main motivator of business owners to maximize their contributions to a Defined Benefit Pension Plan. The second most common reason is to save for a financially secure retirement.
Pensions, Schmensions
A few of you reading this may be lucky enough to still have a pension through your employer. But the days of working 40 years for a company with fabulous benefit packages – you put in your time then, upon retirement, are guaranteed an income for the rest of your life – are gone for most rank-and-file workers. Today, those who work in the private sector or who are self-employed can expect little to none of these benefits in their golden years. Bottom line you can’t count on a pension to fund your retirement. Unless you set one up yourself.
For Business Owners Planning For Retirement Fall Squarely on your own shoulder. Setting up a Defined Benefit Pension plan may be a great way to ensure you have a retirement income you can’t outlive while benefitting from huge tax deductions along the way. Tax planning is a simple way to make your business more valuable and profitable.
Personal Defined Benefit Plan: Small Business Owners fill the retirement savings gap with their own Private Pension:
But there is a program structured for small business owners – that is, those with just a few employees or who work as sole proprietors – generally around their 50s, who want to sock away more for retirement and are looking to reduce their tax bills. It’s specifically for folks who earn high enough incomes to afford to put much more away than is allowed with just a 401(K) plan.
This type of advanced financial planning tool is called a “Defined Benefit Plan”. One type of plan is specifically called a “Cash Balance Plan.” Participants can deduct their contributions, resulting in large tax deferrals, all the while creating their own “personal” pensions. Much like the pension plans our parents or grandparents enjoyed, these will guarantee a set monthly payment in retirement through the rest of your life. This is assuming you make the appropriate contributions to the plan. Remember not all plans are created equal, guarantees are based on the claims-paying ability of the companies you are working with on your plan.
Personal Defined Benefit Plan contributions are mostly based on a combination of your age and income. The younger you are, the less you can contribute, as the money has more time to grow. But you may be able to contribute nearly $300,000 per year for yourself. This is potentially above and beyond what you can put into a 401(K) profit-sharing plan. In fact, to maximize potential contributions and lower your tax bill in the current year, as well as tax deferral for the savings, your Fiduciary Financial Planner will be able to structure these two plans together for you.
A 55-year-old- business owner can potentially contribute more than $207,900 to a Cash Balance Pension Plan in 2024. This is in addition to the $76,500 maximum allowed into a Profit Sharing 401(K). These numbers will likely continue to increase over time.
Talk with your Los Angeles financial advisor about how much tax saving you could see with a Defined Benefit Pension Plan, as well as other tax planning strategies you are likely missing out on.
As with anything, there are pros and cons to a Cash Balance Pension Plan. Let’s take a look.
The ideal candidate for a Personal Defined Benefit Plan for Small Business Owners
Cash Balance or Defined Benefits Plans are best suited for small-business owners (including the self-employed) who are facing high tax bills and want to put away more money in a tax-deferred manner. For most of the many Defined Benefit plans I’ve set up over the years, lowering their tax bills now has been the main benefit objective. Financial security and saving for retirement come in a close second. Ideally, you would have the desire or ability to put away $70,000 to $500,000 or more for the next 5 to 10 years between your 401(K) and Defined Benefit Plan. The potential tax savings could easily top a million dollars over the next decade.
Personal Defined Benefit Plan CASE STUDY: The Saver
The business – let’s call it Really Smart Partners for discretion purposes –was getting killed last year on taxes as its income was expected to keep growing by leaps and bounds. The 401(K) profit-sharing plan was modified, and a new Defined Benefit Cash Balance Plan was established to maximize the contributions the business owner was allowed to make into both. (Bigger contribution, bigger tax deferral) In this case, he already had several years of the maximum contributions saved in a taxable account. So even if business dropped off dramatically, he could still fully fund the plan over the next few years. The big tax savings now? Say hello to literally over $300,000 per year in additional potential tax-deferred contributions.
What could your business do with an extra $150,000 in tax savings?
Personal Defined Benefit Plan CASE STUDY: The Sprinter
For other business owners, the Personal Defined Benefit plan can be more of a sprint in the last few years leading up to retirement. You NEED to put away a large amount of money. To help pay the least amount of taxes on your hard-earned money. Also to have any chance of maintaining your standard of living into retirement. The huge tax benefits and deferral make it much easier to put even more money away. Making it easier to put more away also makes it easier to get on track for retirement.
Personal Defined Benefit Plan Drawbacks
Opening and maintaining a Personal Defined Benefit Plan is more complicated than opening a basic IRA or even maintaining a profit-sharing plan. There will be a few IRS hoops to jump through to set up and fund the thing. As with so many things in life (sigh), bigger benefits may come with some bigger headaches.
Don’t be dazzled by the dream of guaranteed lifetime income or huge tax deferrals. Alas, some of the best things in life are definitely not free. To obtain these things you actually have to contribute money, and often quite large amounts of money up top. Furthermore, you will need to fund your plan consistently at a hefty minimum level each year. Even if business drops off, you will still be required to keep up your minimum contributions. Plans can be reworked, but that can be costly, and options are specifically limited. To stay compliant with IRS rules, you will also generally need to keep the plan in place for at least five years. You will have to work with an actuary to do all the fun actuarial things that go into calculating and analyzing the plan. Don’t worry; we take can take care of all of this for you.
Like your Pensions, IRA’s or 401(K) distributions for Defined Benefit Plans will be taxed as regular income. To reiterate again these plans work best for people who can commit to at least 5 years of contributions. There are IRS penalties for taking money out prior to 59 ½. Further early distribution may put the viability of the plan in jeopardy.
Playing catch up with a Private Pension for Retirement
If you are behind on saving for retirement – and trust me, many people are woefully behind in a fog of denial and credit card debt – don’t feel bad as long as you take action NOW and get your financial house in order. As a small business owner who earns a good income but is starting late, maxing out an IRA is not going to cut it. Even maxing out a Profit Sharing 401(K) with contributions above $50,000 may not really be enough. At least if you want to maintain your standard of living in retirement.
By the time they come to me to a Fiduciary Financial Planner LA to discuss if a Defined Benefit Plan is right for them, most people have already explored or maximized the other easier and more flexible options before setting up a personal pension via the Cash Balance Plan. So for them, it’s well worth investing the money, time and effort. A good talk with your trusted fiduciary Certified Financial Planner™, working with your CPA, should be able to help you figure out if this vehicle is the right option for you. More importantly, it helps you figure out how to maximize the benefits of the plan for your specific financial dreams and goals.
Cost of Retirement Calculator
Is your financial plan going to get you where you want to go? #FinancialFreedom Perhaps a Cash Balance Pension Plan can get you there faster.
Until next time, and as always Be Fiscally Fabulous. Remember Your Money Matters. It’s not what you make but what you keep. If you would like to see how Financial Advisor Los Angeles can help you save on taxes with a Cash Balance Pension Plan, schedule an initial consultation with us.
DAVID RAE, CFP®, AIF® is a Los Angeles- retirement planning specialist with DRM Wealth Management. He has been helping small business owners reach their financial goals while saving on taxes for nearly two decades. NBC Nightline called David a Tax Wizard. He often appears as a financial expert on the CBS, ABC, NBC and KTLA news stations. A regular contributor to the Advocate Magazine, Forbes.com and Huffington Post as well as the author of the Financial Planner Los Angeles Blog. Follow him on Facebook, or via his website www.davidraefp.com
How To Lower Your Small Business Taxes With a Solo 401(k)
The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual. And do not constitute an endorsement by DRM Wealth Management or Financial Advisor Los Angeles David Rae. Guarantees are based on the claims-paying ability of the issuer. Talk to your independent financial planner to find out if a defined benefit plan can help you lower your tax liability. “Personal Defined Benefit Plan for Small Business Owners Defined” Copyright 2021.
Connect With David Rae, Financial Planner LA
David Rae, CFP® AIF®
President / Founder DRM Wealth Management LLC
1(323) 905-4380
david.rae@financialplannerla.com
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Quick question- Can I use my existing IRA to fund a Personal Defined Benefit Plan?
I see that there can be a hefty upfront contribution to make for at least the 5 years (even if business falls off) and I am wondering if there’s a provision that allows me to move money from an existing IRA to the PDB????
I realize that we are still talking about pre taxed money but not sure IRS allows for this sort of loophole?
Would be great if they did because I would hbe fulfilling the contribution minimums plus getting the in year tax deduction.
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