This article will begin a slight change in our direction moving forward. We are looking for ways to have more capital to use for contributing to God’s work. Please note, we are not tax advisors or attorneys. This is purely educational and informational. Consult your advisors before attempting to utilize any of these concepts discussed. Let’s dive in.
As a high-income small business owner, you’re likely exploring ways to maximize your retirement savings while minimizing your tax liability. One powerful option to consider is a defined benefit plan as opposed to a defined contribution plan. In a defined contribution plan the amount put into the plan is defined. A 401(k) is a type of defined contribution plan. A defined benefit plan defines the benefit coming out of the plan in retirement. In this article, we’ll delve into the tax advantages of these plans and why they might be an excellent fit for your financial strategy.
What Is a Defined Benefit Plan?
A defined benefit plan is a qualified retirement plan that provides a specific benefit to participants upon retirement. Unlike a typical 401(k) plan, where individual employees bear investment risk, a defined benefit plan places that risk on the plan trustee. Here are the key features:
- Higher Contribution Limits: Defined benefit plans allow for larger tax-deductible contributions compared to many other retirement plans. This makes them attractive for business owners aiming to set aside substantial amounts for retirement.
- Tax Deductibility: Every dollar contributed to a defined benefit plan is tax- deductible. This feature significantly reduces your current tax obligations. Additionally, subsequent earnings on these contributions grow on a tax-deferred basis, allowing your wealth to accumulate without immediate tax burdens.
Misconceptions and Cash Flow Considerations Misconception No. 1: Plans Are Too Tough on Cash Flow
While it’s true that defined benefit plans can be administratively costly for the plan sponsor, they offer substantial tax savings. During years of higher cash flow, the tax benefit from a defined benefit plan can outweigh that of a 401(k) plan. Business owners who can consistently contribute substantial amounts over time should seriously consider this option.
Misconception No. 2: Administrative Complexity
Yes, maintaining defined benefit plans involves administrative complexity. However, the long-term tax advantages often justify the effort. These plans can put business owners in lower tax brackets and allow them to retain more of their profits.
Tax Benefits of Defined Benefit Plans
A defined benefit plan can provide employees and employers (technically as an individual employee) with a fixed benefit upon retirement. These plans offer several tax advantages for both employers and employees:
- Tax Deductions for Employers:
- Businesses can generally contribute more to defined benefit plans than to defined contribution plans. These contributions are tax-deductible for the employer.
- The ability to make larger contributions allows employers to reduce their taxable income significantly.
- Predictable Tax-Deferred Growth:
- Contributions to defined benefit plans grow tax-deferred until retirement.
- Employers can deduct these contributions, and the investment earnings accumulate without immediate tax consequences.
- Rolling Over at Plan Termination:
- Upon plan termination, any remaining funds can be rolled over into other retirement accounts, such as an IRA or another qualified plan.
- This rollover allows for continued tax-deferred growth.
- Employee Tax Benefits:
- Employees appreciate the fixed benefit provided by defined benefit plans.
- The predictable retirement income stream helps with financial planning.
- Complexity and Costs:
- Defined benefit plans are more administratively complex and costly to establish and maintain compared to other retirement plans.
- However, the tax benefits often outweigh these drawbacks.
Conclusion
In summary, defined benefit plans provide an avenue for high-income small business owners to supercharge their retirement savings while enjoying significant tax benefits. If you’re in a position to contribute consistently and seek long-term financial advantages, consider exploring this powerful retirement planning tool. For additional information you can visit the IRS website, IRS.gov.
Please note: All charts and numbers are for illustration purposes only. Accuracy is neither warrantied nor implied. We are not attorneys or tax advisors. This information is educational only. Not to be considered as advice or recommendations. It is imperative that you consult with a tax advisor and/or attorney when considering any of these concepts. In addition, it is critical that the attorney, tax advisor, and financial advisor are knowledgeable and practiced in these areas.
If you would like help finding such an advisor, we will be glad to introduce you to an experienced planner with your best interest in mind. Please give us a call at 1-800-522-4324
