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When is a Defined Benefit Plan a Good Option for Business Owners?
A Defined Benefit Plan can help older owners of highly profitable businesses squeeze twenty years of savings into ten.
Once a standard of businesses, defined benefit plans (or pensions, as you may know them) have been replaced nearly wholescale by defined contribution plans such as the 401(k). Defined benefit plans are costly, administration-heavy plans that can be difficult to keep running successfully. Yet for the right small business, a defined benefit plan might be a choice that provides you with the largest retirement contribution and most tax savings possible.
So why would you want to set up a plan and in what cases might a defined benefit plan be your best option? Read below.
Profitable Business Owners Might Squeeze Twenty Years of Retirement Savings into Ten
A defined benefit plan provides a fixed, pre-established benefit for employees at retirement. Employees do not contribute to the plan, and all the investment risk and responsibilities lie with the employer who is managing the plan. Because of this, many individuals who set up defined benefit plans are a sole owner or one of just a few employees.
A defined benefit plan allows the business owner to set aside much more money for retirement than the typical IRA or 401(k). A defined benefit plan needs to grow large enough to provide the required annual payment by the time a participant retires. Today’s annual contributions are determined by actuarial assumptions based on age, investment return, and other factors. In many circumstances, annual contribution limits can be very high. For example, if a business owner is in their fifties and is just establishing a plan, the annual contributions needed for the plan to reach its required size by age 65 can easily reach six-figures.
A defined benefit plan with this level of annual contribution can allow a business owner to squeeze twenty years of retirement savings into ten. Ideal candidates for a defined benefit plan will be able to put away $100,000-$150,000 a year for at least ten years. Because all contributions are tax-deferred, the tax-savings element of the plan can also quickly outweigh the higher administration costs.
Defined benefit plans are not without risks. Business owners are required to make a minimum funding contribution each year. This requirement is not dependent on how well the company is doing; even if the firm has a bad year, they still are required to make the plan contribution. The administration fees are more expensive than traditional 401(k) plans and thorough planning and consultation at the outset is required. But in the right circumstances, defined benefit plans provide successful business owners achieve maximum retirement contributions and tax savings. If you would like insight and assistance navigating your retirement plan options, give us a call at 844-377-4963 or use the “Let’s Talk” tool in the right sidebar.
Quick Facts – Defined Benefit Plans
- 100% funded by required annual employer investments
- Annual contribution requirements determined by actuary
- Can allow for far higher contributions than 401(k)s
- Expensive to administer and maintain
- Employer may claim $500 tax credit for plan start-up costs in first three years