If you run a business, a Personal Defined Benefit Plan could save you tens of thousands of dollars (or more).
How do you know if a Personal Defined Benefit Plan is right for you? What are the advantages of setting up a Plan? These are the questions we’ll answer in this article.
Personal Defined Benefit Plans work best when a business owner is at least 35 years old and contributions are being limited by their current retirement plan.
Other retirement plans, such as SEPs or Profit Sharing Plans, have limits of $66,000 and $73,500, respectively, per year. These limits can be an issue for business owners who want to deposit higher amounts. Fortunately, Personal Defined Benefit Plans allow very high tax-deductible contributions ($100,000 to $250,000+ per person, per year). This level of contribution is not possible with any other type of retirement plan. What’s more, Defined Benefit Plans can be used in conjunction with other retirement plans to further increase the deductible limit.
In addition to the dollar limits, specified above, contributions in other retirement plans may be limited further based on Plan-eligible compensation.
For example, SEP contributions are limited to 25% of Plan-eligible compensation. Profit Sharing Plans have a similar limit. This means if compensation were only $100,000, SEP contributions would be limited to $25,000. In fact, compensation needs to be at least $264,000 to allow the full SEP contribution of $66,000. To max out a Profit Sharing Plan with a 401(k) feature Plan-eligible compensation of $174,000 is needed to contribute the full $73,500 ($66,000 without catch-up contribution).
On the other hand, standalone Defined Benefit Plans are not subject to the 25% limit. Thus, for a given level of compensation, a higher contribution can be made to a Defined Benefit Plan.
Who benefits from the fact that the 25% limit does not apply to Defined Benefit Plans? Most often, those who are either independently wealthy or have other income (from their or their spouse’s W-2 job). With other sources of income covering their expenses, the person may want to save a big chunk of their business income. That’s possible with a Defined Benefit Plan. It is not, however, available in other retirement plans.
As mentioned, Defined Benefit Plans enable large, immediate tax deductions. What’s more, these deductions may lead to other deductions, such as:
Once contributed, contributions grow tax-deferred and can be rolled over to an IRA at retirement. Lastly, Defined Benefit Plans may reduce payroll taxes, because for a targeted deduction, wages can be lower than other retirement plans. See the section “Defined Benefit Plans Not Subject to 25% Limit” above.
In addition to the advantages described above, there are no employees who require benefits. In businesses with employees, nondiscrimination rules require that employees receive a benefit. Although the tax savings may be worth the cost of employee benefits, Personal Defined Benefit Plans do not have this additional cost. Rather, 100% of contributions go to the owner.
As you can see, Personal Defined Benefit Plans are a powerful tool. They can provide significant tax savings without any employee benefit cost. Put another way, you can save taxes while you fund your own retirement!
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