Saber Pension has discussed Defined Benefit Plans as a guest on several podcasts. In this post, we have provided the Defined Benefit Plan podcast transcripts and access to the full shows. Note that we have made minor edits to the transcripts for readability purposes.
For your convenience, here is an index to the four podcasts that we are featuring:
Aired August 4, 2020. Listen to the full show here.
Andy Wang: This is episode 153 with CEO of Saber Pension and Actuarial Services, Brent Henningson. Welcome to Inspired Money. My name is Andy Wang, a Managing Partner at Runnymede Capital Management. Each week, we bring you an interesting person to help you get inspired, shift your perspectives on money and achieve incredible things. From making it to giving it away, Inspired Money means making a difference, creating something bigger than oneself, and maybe, just maybe, making the world a better place. Thank you for joining me.
Andy Wang: In this episode, we’re talking about a specific retirement plan: the defined benefit plan. This topic applies to business owners, entrepreneurs, and solopreneurs. If this isn’t you, I hope that you’ll still find this episode interesting. There are not that many ways to reduce your taxable income and accelerate retirement savings, so it’s good to arm yourself with this knowledge. Perhaps you’ll be able to help a friend or your family. We’re talking with Brent Henningson, CEO of Saber Pension and Actuarial Services. He specializes in defined benefit plans or DB plans. In this episode, you’ll learn if your income allows for it, how to save up to $3 million in retirement savings ($3.4 million now), the differences between a 401(k) retirement plan and a defined benefit plan, and the professionals needed to set up and maintain a DB plan. Now, let’s get inspired with Brent Henningson.
Andy Wang: Brent, welcome to Inspired Money. I’m so excited to have you on the show.
Brent Henningson: Thanks, Andy. It’s great to be here.
Andy Wang: Let’s jump right in. What’s your earliest childhood memory of money?
Brent Henningson: My earliest childhood memory [of money] is going on vacation with my family, and my parents giving all five kids money to spend on souvenirs, and my brothers and sisters just blowing all their money on video games and candy, and me just hanging onto that money and really being thoughtful about how I was going to spend it. So, I think at an early age, managing money really interested me.
Andy Wang: Of the five kids, you were the one who became the actuary, so everybody sort of had a different personality about money. Do you think that still holds true today?
Brent Henningson: I’d say my brother and sisters have actually gotten a lot better with money, but I have the reputation, I guess, that when they have a money question, they usually call me.
Andy Wang: Most people probably don’t get excited about actuarial services but helping business owners to reduce taxes and accelerate retirement savings, that can be really exciting. You’re Chief Executive Officer of Saber Pension and Actuarial Services, a third party administration and actuarial firm. How did you end up in this pretty specialized area?
Brent Henningson: My journey’s been interesting because I always gravitated toward math, but I never knew in junior high and high school what I was going to do with it. In my freshman year of college, I actually declared pre-law. So, I still didn’t know even at that point. But I found actuarial science and saw that it was rated number one at the time by U.S. News & World Report, as far as an occupation that pays well, that has a good work-life balance and is a pretty stable career. I decided probably sophomore year in college that I wanted to be an actuary and just gravitated toward the defined benefit space because I liked consulting with clients. I [also] liked the quantitative part. It’s just a good mix of being able to interact with people, but at the same time, use my mathematical skills. I spent over 15 years with a really large global provider, and their target market was Fortune 1000 companies. So, I was working on some of the largest plans in the Phoenix area. Some of them had billions of dollars [in Plan assets]. It was really interesting work and I liked it, but between the time I started in 2001 and when I left there, there was more and more focus toward 401(k) plans, and [actuarial work related to large defined benefit plans] was a slowly dying industry. That’s when I decided in 2018 to switch over and focus on small plans, because that’s a growing area, and start my own business and be able to build my own vision.
Andy Wang: And you started Saber Pension just a couple of years ago?
Brent Henningson: Yes, almost exactly two years ago (five years ago now). I started in May of 2018.
Andy Wang: Let’s talk a little bit about that shift. When we talk about defined benefit plans, or a pension plan compared to a defined contribution plan or 401(k). Can you give us a little historical context just as a starting point?
Brent Henningson: Pensions really started making headway after the Second World War and picked up steam. Then, there was a number of legislative changes that made sponsoring a defined benefit plan as an employer more onerous. Those changes were needed because there were employees that were cheated out of large sums of money by corporations. At the same time, it did make it more difficult for employers to want to sponsor [defined benefit plans]. There’s been a lot of factors that have gone into this shift, but some of them are [that] plans started getting really large relative to the size of the organizations [sponsoring them]. You’ve heard the joke that with GM, [that] they’re a pension company that does cars on the side. [This is] because their pension [plan] became so large relative to the size of their company, and any changes in the assets and liabilities would flow through their financial statement. It was a disaster to be able to hit quarterly earnings when you have those kinds of surprises. So, you started seeing employers shift more to 401(k) plans because [it was] easier to predict [their] cost and the employers were shifting a lot of the risk to the employees.
Andy Wang: You mentioned that defined benefit plans for smaller companies is a growing area. Why is that?
Brent Henningson: Well, the motivation behind starting a plan for a large corporation was attraction and retention, and people don’t stay with employers as long as they used to. So, it became less appealing, I think, for employees. But with the small plan market, it’s not about attraction retention in most cases. More often than not, it’s about the owner being able to save for his or her own retirement while taking large tax deductions. So, it’s more of a tax/retirement play as opposed to attracting and retaining employees.
Andy Wang: Right. So, it’s using an older vehicle, but in a different way it sounds like.
Brent Henningson: Yes, in a different way, and it lends itself to the objective of owners maximizing their own retirement, because with a 401(k) plan, you can add a profit sharing component, but you’re going to be limited to roughly $60,000 a year ($73,500 a year now) that you can put in per person. That’s a decent sum of money, obviously. It’s more than most people would probably want to save in a year. But for those owners that maybe are 50 or 55 [years old] and they spend all their time on their business and all their resources, and now it’s time to save for retirement, and they need to put away $100,000 or $200,000 a year to make up for lost time, that’s where a DB plan can be a really great solution.
Andy Wang: So, let’s talk about that because putting away $100,000 to $200,000 per year, that’s a big sum of money. Who should be taking advantage of this? What does the individual look like? What’s the ideal business profile of the clients that you work with who do set up DB plans?
Brent Henningson: The number one criterion is they somehow are being limited on their retirement contribution. So, that could be the $60,000 ($73,500 now) contribution I talked about. Sometimes it can be, for example, with a SEP plan, you can only put in 25% of your pay. So, you may be limited because of that, and it may be under $60,000 ($66,000 for a SEP now), but you’re still being limited. The number one criterion is if you’re somehow as an owner wanting to put in more money than you’re allowed, then it’s worth exploring a DB plan. The other thing, too, is if you have too many employees, then the cost of covering those employees will eat up any value of the tax deduction you’re getting. So, part of the analysis we do is weighing those two factors against each other.
Andy Wang: Does an employer have to offer this benefit to all employees?
Brent Henningson: You have to provide it to enough employees. You can usually exclude some employees. You just have to pass what they call nondiscrimination testing. But in terms of how much it generally costs, my rule of thumb is 8% to 10% of staff payroll, so it’s not really a headcount thing. It’s more payroll [related], because if you have 10 employees and the average salary is $10,000 to $20,000, it may be a lot easier to accomplish than having five employees who are getting $100,000. There are cases where someone’s making more than the threshold, which is $125,000 a year ($135,000 a year now), you can exclude them and that actually helps you rather than hurt you. But for most employees, it’s going to cost 8% to 10% of payroll.
Andy Wang: Okay, so that’s a good rule of thumb to go by. But I guess if somebody were a solopreneur, does that make it just an even easier analysis if there’s just one person?
Brent Henningson: Yes, that’s definitely the ideal, because now every dollar that they put in is going to themselves as the owner. And if they have a spouse that is employed at the business too, that’s even better because they can double-up that deduction in some cases.
Andy Wang: So, if you have one professional owner of the business who’s making the lion’s share of the payroll and there’s an assistant or two assistants, it sounds like, given your rule of thumb, that that shouldn’t be too onerous. You’re not creating massive complexity if you have a small staff, but you have an owner plus one or two assistants.
Brent Henningson: Yes, that’s absolutely right. If you have an owner and two assistants, that generally is going to make sense. There is an age component too…going back to how defined benefit plans work. With a 401(k), you’re defining the contribution, just like the name defined contribution says. You can put in $19,500 ($22,500 now and $30,000 with the catch-up contribution). You can do that every single year, but what that contribution ends up being worth at the end, at retirement, is anybody’s guess because it’s going to be based on what the market earns and what they invested in. With a DB plan, it’s the exact opposite. You define upfront what the benefit will be at retirement, and for an owner who wants to max out, that could be [about] $3 million at age 62 ($3.4 million now). They could get a payout of roughly [$3.4 million]. You can imagine someone who’s, let’s say 50 and they have 10 to 12 years to get to that horizon, they can put in a lot of money to get to that [$3.4 million]. Someone who’s younger, let’s say someone who’s 25 and they have like 40 years to get there…the contributions for someone that young usually aren’t going to be worth it. Usually, they need to be at least late thirties or early forties for it to make sense.
Andy Wang: But it does come down to how much income there is also, right? So, if you have a 30 year old, who has an online business, for example, and they’re generating a lot of income annually, it may make sense to set up a DB plan? To what extent does the age does come into play when calculating how much one can put into it?
Brent Henningson: For example, at age 40, someone can put in about $100,000 a year. If they’re younger, like 35, maybe it’s $75,000. But if you get too young…if you’re 30, it could be about the same amount that you could put in a profit sharing plan. So, why would you pay the extra money to administer a defined benefit plan when you can get to the same place using another vehicle that’s easier?
Andy Wang: Right, that makes sense. So, it’s not black and white. It does take some analysis, some crunching the numbers on a case-by-case basis to see if it is optimal for that individual.
Brent Henningson: Yes, absolutely.
Andy Wang: Are there certain professions or industries that really stand out as being a great fit?
Brent Henningson: Yes, the [professions] that really utilize these plans are physicians, dentists, lawyers. Those are the traditional users of defined benefit plans. But our economy’s changed a lot. So, we have a lot of consultants. And that’s where I pick up a lot of clients too, all kinds of different consulting. They could be consulting on digital marketing, branding, any kind of consulting. There’s opportunity for them to make a lot of money and a lot of times they’re on their own. They may have one employee, they may not. And so, they’re a really good candidate as well.
Andy Wang: Does the source of income matter? I remember someone once telling me that a DB plan makes sense for someone who has a secondary source of income, whether that’s doing consulting on the side or a paid board member compensation.
Brent Henningson: Yes, I actually have a whole blog post about what I call the side business defined benefit plan. The reason that works really well is because a lot of times that income isn’t needed for the person to live on. So, they have their full-time job, they live off of that. Either that, or maybe their spouse has a full-time job, and their family lives off that. And then they have this business on the side that essentially could be used all for retirement or most of it for retirement. And that’s where when you look at that income and the percentage of income that can be saved in a DB versus a 401(k), sometimes…someone can almost save all of that money in a DB, whereas in a 401(k), they’re going to be limited to roughly 25 percent of pay. I’ve had situations like that where someone’s 40 and they’re making $100,000 and they want to save most of that and they’re able to do that in the DB plan.
Andy Wang: That’s because, in this example, you’re looking at the $100,000 as a secondary source of income that’s not really needed.
Brent Henningson: That’s right. Yes, they would like to save as much of that as they can, but the 401(k) limits won’t let them do that.
Andy Wang: Right. And then since we were talking about kind of things to look out for, I know that defined benefit plans are different from a 401(k) in that there’s a requirement for the company to contribute. Tell me if that’s correct, incorrect, or how that plays into the decision when considering a DB plan.
Brent Henningson: Yes, it’s absolutely correct that in most years, there’s going to be a requirement to put something into the plan. How much they have to put in is what an actuary like me determines. How it works is you have this liability (we talked about how you define the benefit upfront), and then at the same time, you have money you’re putting into a retirement account, which is the asset backing that liability. They don’t have to be equal. In fact, they can stray from each other quite a bit. There’s a lot of flexibility on how that liability is funded. But there are parameters around a minimum amount you have to put in to fund it. There are also parameters around the maximum amount. And so, to give you an idea on the maximum side, you can fund 150% of the liability. So, in good years, I encourage my client to fund towards that 150% of the liability, so that if [they] have a lean year, that’s going to make the minimum requirement a lot lower. In fact, it could even make it zero.
Andy Wang: With that consideration, if there is a stock market crash, does that create a scenario where the sponsor of the DB plan would have to contribute more to make up for that?
Brent Henningson: It’s more complicated than it sounds because it depends on the funded status of the plan too. If it’s a really underfunded plan, they just amortize that over a seven-year period (a 15-year period now), so it’s not too big of a deal. But there is this corridor, where if they’re in that corridor, it can be a dollar-for-dollar impact, at least for a part of it. And that’s why I always encourage clients to work closely with a financial advisor because I can’t give financial advice as an actuary. I’m not a licensed advisor for managing money, but typically advisors are not recommending that their clients be at 100% equity because of that volatility component.
Andy Wang: Got it. Yes, I’m a financial advisor and we have worked with clients managing their DB plans. So yes, there’s a definite need for prudent investing. Since we’re talking about the requirement to contribute every year, it sounds like it’s important to have a regular source of income, like it should be fairly consistent. Does it make sense for somebody who is an actor or a screenwriter or a speaker because sometimes their income can be variable year-to-year?
Brent Henningson: Yes, it’s ideal for someone to have a consistent stream of income. I have clients, though, that, for example, are attorneys, and they’ll get a large settlement one year and then they may not make much money at all for the next couple of years. So, that’s where knowing upfront that the income is going to be irregular, we can design the plan so that we don’t set the bar too high and then they overfund it. They can even set aside some money for the next couple of years for making that minimum requirement. There is the ability to freeze the plan if needed. It’s just that you can’t retroactively cut back a benefit. So, you have to have some foresight that the next couple of years might be lean, let’s freeze the plan, then we’ll kind of see where it goes. So, it’s nice knowing all that upfront so that we can design the plan to meet that objective.
Andy Wang: As is the case often with money, communication’s important because you need to do proper planning, and that holds true with the defined benefit plan as well.
Brent Henningson: Yes, that’s absolutely right.
Andy Wang: Brent, we’ve talked about what industries DB plans are pretty common [where] somebody would consider a DB plan. Can you share with us maybe a case study of somebody that you’ve worked with and how it [made] sense on a practical level?
Brent Henningson: Yes, so I’ll give an example of someone that has employees because that’s a little more complicated (when you’re a high-income owner [with no employees], it’s almost a slam dunk). For example, let’s say somebody is 55 and they want to save as much as they can. For somebody that age, they might be able to save $200,000 to $250,000 per year in a DB plan. If somebody like that had $50,000 in staff payroll, they put in $250,000. Let’s just say, that they’re going to get a 40% deduction when you take into account federal, state, QBI, (qualified business income deduction) that could come into play. Let’s, just to make the math easy, say it’s 40%. So, somebody like that could save $100,000 in taxes, and if they had staff payroll of $50,000, using my rule of thumb, let’s use 10 percent of payroll, that would cost them $5,000 in staff benefits. And so, when you compare $100,000 in tax savings to $5,000 in staff benefits, clearly, it’s it makes sense for somebody like that to put in a plan.
Andy Wang: That is compelling.
Brent Henningson: Yes, it is. The biggest barrier is just how much you want to put in because there are situations where they only want to put in $30,000. And it’s like, okay, that’s fine, but you shouldn’t do a DB plan because a profit sharing plan is going to meet your needs. So just stick with that.
Andy Wang: When you work with your clients, do you see them using a 401(k) in conjunction with the DB? Or is the DB an alternative to a 401(k)?
Brent Henningson: Usually in conjunction, because in an owner-only example, if they’re over 50, they can put in $26,000 ($30,000 now) in addition to the DB plan, and they can also do a profit sharing contribution of 6% of their pay. If they do more than that, it messes up the DB deduction, but they can get in more money doing both. They can just use a Solo K, so they don’t even need to pay a third party administrator to do that. So usually, it’s in conjunction. If they have employees, my experience is it’s about 50 percent of the cost to use what’s called a defined benefit defined contribution combo plan, which is kind of passing nondiscrimination testing using both types of plans. The 8% to 10% takes into account that that’s the direction they would be going. If they were doing a standalone DB, it might be 15% or 20% of payroll. So, it’s almost always going to make sense to use the 401(k) in conjunction.
Andy Wang: At Saber Pension, do you get involved on the 401(k) side, too? Do you handle that for clients who have the combo plan or are you specifically addressing the DB part of the work?
Brent Henningson: I just specialize in the DB portion, but I do the combined nondiscrimination testing between the two plans. And then there’s a handful of third party administrators who specialize in just 401(k) plans that I’ll partner with, and we work together to help the client with their retirement plan.
Andy Wang: Okay, so let’s talk about the typical service providers. Who are the professionals needed to set up a plan and to maintain it?
Brent Henningson: Obviously, the third party administrator, and with a DB plan, you need an actuary to sign off on it. I do both the third party administrator and the actuarial roles. They would need, or at least I would highly recommend, that they have a financial advisor, especially if they have employees, because they’re going to have the fiduciary responsibility to manage that money. So, that would be another team member. Then, obviously you have the CPA that would be involved because we’re dealing with taxes. You have the custodian. The custodian [would be] a Schwab or Fidelity, or whoever the advisor uses for a custodian. That firm would actually hold the money and usually keep track of how much the investments earned in terms of account balances, and then in some cases, you need an ERISA attorney. In most cases, you don’t, because if they can use a pre-approved plan like the one Saber Pension uses, they don’t need one. But occasionally you do run into situations where we need to get an attorney’s advice on a more complicated situation.
Andy Wang: So, this is why defined benefit plans have a reputation for being more complex. In your view, how complex is it really for a business owner to implement, fund and manage on an ongoing basis?
Brent Henningson: So, there’s a lot of complexity, like you say. 401(k) plans have a lot of complexity too, but in a different way. And I think because people are more familiar with them, they don’t seem as complex. But part of it is when you hire a third party administrator, they know all the complexity and the rules, and they make sure that the business owner has all the information they need to comply with that. So obviously, the business owner, just like they don’t have to learn the tax law because I mean, taxes are extremely complicated. The CPA helps them understand what they need to do. That’s my job to make sure that they check all those boxes, so they don’t get into trouble. Towards the end of last year, I had a lot of prospects reach out to put in a plan because that used to be the deadline (the end of the tax year). And some of these plans, I mean, we were designing them and adopting them within a week. So, they can be done quickly if somebody is ready. They can be done really fast.
Andy Wang: Are there dates that people need to consider?
Brent Henningson: The SECURE Act changed the due date when you have to set up the plan. Like I said, it used to be the end of the tax year, and now it’s basically the date when you file your taxes for that tax year. So, if you have a calendar year S-Corp, let’s say, and they extend their tax return all the way until [9/15/2023], they would need to have the plan implemented by that date to be able to get a  tax deduction. It also made it a little more complicated as well, because not only would they need to have it implemented, they would have needed to open the retirement account, funded it, and then a month later, the TPA would have had to file the Form 5500. So, essentially it created an opportunity for clients to know where their taxes were before deciding to put in the plan, but it also caused some logistical issues for those who waited until the very last minute.
Andy Wang: Do you have another case study example that we should think about?
Brent Henningson: Yes, one example that comes to mind, and this would be an unusual situation because it’s just it’s so compelling and so good. But I had a business owner who was in their 60s. Their spouse was also an employee of the business, and they had no employees. And this person had a large stream of income coming in year one, and that income was going to continue, but it was going to continue at a lower rate. And so, what they were looking for is the largest deduction possible. They wanted to frontload the contribution stream and fund it at 150%. The solution that we came up with was to do a defined benefit plan. You and your spouse will be in the plan. You’re going to do 401(k) as well and max that out to the extent you can to frontload those contributions. They ended up being able to deduct in year one roughly $900,000. It had to do with the amount of income, the fact that they were close to retirement, and that the spouse was also employed. So, that would be within the guidelines of what you’re able to do. It’s just all those [factors] aligning to create a deduction that large is pretty unusual.
Andy Wang: Brent, to what extent is that open one up to a potential audit?
Brent Henningson: I don’t have any statistics because it’s hard to get those statistics, but I would say that it wouldn’t really increase or be a red flag in terms of creating additional scrutiny on the audit. For a lot of these plans, too, where they’re owner-only plans, they don’t even have to file anything until they have over $250,000 in assets. The good thing about these types of plans is actuaries have done a really good job regulating themselves. So, we have Actuarial Standards of Practice, we have a disciplinary counsel, and actuaries typically have the personality to do the right thing. So, because of that, there hasn’t been a big need to scrutinize all the work that actuaries do. In the 80s, there was a big shake down with the IRS targeting these types of plans. But since then, there hasn’t been anything that’s really notable.
Andy Wang: It seems like one of the few places where one can actually get a tax benefit, increase their retirement savings, and it’s all done pretty clearly within the regulation of the law.
Brent Henningson: Yes, absolutely. When owners have employees, it’s really good for the employees too, because, like I said, if they’re getting 10% of payroll, it’s really not [because they are] doing anything additional. That’s just the cost to play, I guess, for the owner. A 10% retirement benefit is really significant. So, it’s not as if the owners are the only ones benefiting. Anyone who’s employed and is getting this type of arrangement is really fortunate.
Andy Wang: Yeah, that sounds like a win-win.
Brent Henningson: Absolutely.
Andy Wang: So, I really appreciate those examples. It makes me think of another major difference between the traditional pension plans of a GM over the past versus for a smaller business. And that’s that old pension plans. They’re always viewed as having an investment horizon of almost forever because you’ve got a large company that is going to be in existence more than a generation of one employee, it’s going to continue for the lifetime of that corporation. That’s different for a small business, right? I know that people talk about a permanency rule. Maybe you can talk about how long do small business owners tend to keep their DB plan?
Brent Henningson: Yes, on the maximum end of the spectrum, usually it’s going to be about 10 years. The reason for 10 years is because the maximum benefit limit phases in over 10 years. So, if someone’s maxing out their amount every single year, after 10 years, they’re going to be at their limit, and then there’s really no reason to continue to maintain that. So, somebody like that would terminate the plan and roll it over to an IRA. On the lower end of the spectrum, it’s a good idea to have the plan open for five years. I think that’s pretty safe to satisfy that permanency rule. Three years is starting to get into a gray area. Anything [under] three years, unless you have a really compelling reason like going out of business or a major financial shock, is going to be hard to justify to the IRS that this was meant to be a permanent plan because it’s going to feel a lot more like a tax gimmick.
Andy Wang: What does the permanency rule say?
Brent Henningson: It’s actually pretty vague. But in practice, five years is pretty safe. So, it doesn’t actually define what permanency means. When you think permanency, you think it essentially goes on forever, right? But clearly, that’s not the case with these smaller types of arrangements. If you go in with the expectation that you’re going to fund this for two years and terminate it…if anyone comes to me with that, I just tell them straight up, that’s not a good idea. You really should plan on having it open a lot longer than that.
Andy Wang: So, people should be really setting a goal of hitting that maximum for the DB contribution, and then they’re rolling it over into an IRA or five plus years is viewed as safe.
Brent Henningson: Correct.
Andy Wang: So, all of this was very informative and helpful. Can you talk a little bit about if someone wants to start going down the road of exploring if a defined benefit plan makes sense for them? What does that look like?
Brent Henningson: So, usually the first step is to see what the numbers look like. And so, they could call somebody like me or another TPA or actuary. And with some data, usually a census showing their employee payroll, birthdates, hire dates, then a TPA could run some numbers to show what the deduction is for the owner and what the staff costs would be. And then comparing the value of that tax deduction, usually at an illustrative level, because we’re not looking at their taxes, and then showing what the cost of the staff benefit is to help them determine if it makes sense to explore further.
Andy Wang: And then it’s a matter of, I guess, setting goals. What is it that they want the plan to achieve and maybe what the time horizon looks like?
Brent Henningson: So, the objective is pretty similar [between clients] from my experience. Usually, the objective is to maximize the defined benefit [for the owner(s)] and meet the statutory guideline on staff benefits. So, it’s trying to weight the benefits [toward] the owner. But there are cases where the owner says, “I really want to take care of my employees, they’re [like] family. I want to take care of them. They tend to stay with me.” So, there are situations like that where the benefit is more equally distributed. There’s a lot of regulations, though, in terms of how to distribute those benefits. So, it’s sort of like layers upon layers, upon layers of rules to make sure that the staff is being treated fairly as well.
Andy Wang: Are there big differences state by state that need to be considered?
Brent Henningson: Not for these types of plans because [they are] governed by the Internal Revenue Code and by ERISA, which are federal guidelines. I heard recently from a CPA, with a client in New Jersey, that [at a state level] any loss created in the corporation because of the defined benefit deduction couldn’t be applied against other earned income that they’re receiving as a full-time employee somewhere else. So, you do have little nuances, I guess, in the tax code state by state. But in general, no, it’s more of a federal patchwork of rules and regulations.
Andy Wang: And since this is the Inspired Money podcast, this sounds like a way for business owners to sock away more toward retirement, save taxes, and it really becomes a vehicle where they can be more intentional and be more impactful with their money.
Brent Henningson: Yes, that’s absolutely right. When you have the right candidate, this is almost a no brainer.
Andy Wang: Can you give us a ballpark idea of what expected costs and expenses there might be?
Brent Henningson: It varies from TPA to TPA, but, in general, it costs a couple of thousand dollars to start a plan. And then, for a one person plan, it’s [maybe] between $1,500 and $2,000 a year to maintain it. So, when you go back to the example that I gave at the beginning of the person saving a $100,000 in taxes and costing $5,000 in staff benefits, you add another $2,000 to maintain the plan. It’s still really compelling.
Andy Wang: I think when you look at all the figures nationally, as far as are people retirement ready, people need ways to sock more away. So, if people are so fortunate to be generating enough cash flow that they can put more away, this sounds very advantageous.
Brent Henningson: Yes, and it’s one of those solution too, because there are other solutions that have compelling tax benefits, but they’re really expensive to implement and maintain. They can still make sense, but it’s nice to have a solution that is fairly [inexpensive] to set up and maintain.
Andy Wang: Any other drawbacks that people should be aware of?
Brent Henningson: The biggest drawbacks we’ve covered. It’s more commitment, putting in money every year. It’s minimizing that asset volatility like we talked about. Where you see people get into trouble is when they’re not aware of those things. And so, whenever I talk to someone who’s interested, those are points that I raise immediately because obviously I don’t want any surprises as they continue to maintain the plan.
Andy Wang: I like to ask all the Inspired Money guests: how do you define success? So, I will address that to you as a relatively new business owner and somebody who’s working with clients and helping them.
Brent Henningson: So, there’s different definitions of success. How I view success holistically is different than how I view it strictly as a business owner. Holistically, I look at doing a really good job for my clients. I’m a father of three daughters, so being there for them, that’s a high priority, obviously. And when we talk about business specifically, when I can help somebody achieve what they’re trying to do and be consultative in a way that helps them meet that objective more efficiently. One thing I really pride myself in is that I get told a lot by my clients, “Wow, you’re really nice. You took the time to explain this. I really appreciate that.” That makes me feel good because I know that I’m helping that person to understand these types of vehicles and how it can help them plan financially.
Andy Wang: Brent, tell us, where can the Inspired Money listener find out more about you and your company?
Brent Henningson: They can go to my website, which is saberpension.com.
Andy Wang: Thank you for sharing a wealth of information that I think that a lot of people can benefit from. And it sounds like if people are interested, it will require a little bit of homework, but it could be very worthwhile.
Brent Henningson: Yes, it does take a little bit of time upfront, but when it makes sense, it’s a good way for them to put away a lot of money. It’s been great to be on the show, Andy, I appreciate you having me.
Aired December 12, 2019. Listen to the full show here.
Kirk Chisholm: Welcome to this week’s episode of the Money Tree Investing podcast. My name is Kirk Chisholm, and I will be your host today. So, today we have Brent Henningson. How are you doing today, Brent?
Brent Henningson: I’m doing well.
Kirk Chisholm: Good. Well, this is an exciting show for all you listeners. This is another one of our tax loopholes of the rich episodes. These are episodes where we try to bring you some really cool and interesting stuff from the deep, dark bowels of the tax and financial industry, where really only the very, very wealthy one percent are able to take advantage of some of these, which is not necessarily the case all the time, but this is the type of people that typically invest in these strategies and we are bringing them to you so that you can do the same. So, we’re talking with Brent Henningson, who is the CEO of Saber Pension and Actuarial Services. Brent is a CPA, and he primarily works with defined benefit plans. So, how’s it going, Brent?
Brent Henningson: It’s going great, Kirk. I’m actually a TPA, which is a common misconception, but a third party administrator works, like you said, on defined benefit plans.
Kirk Chisholm: It’s not the first time I’ve made that mistake, and I’m sure other people are wondering the difference. But what’s the difference between a CPA and a TPA?
Brent Henningson: A CPA is somebody who obviously specializes in taxes. A TPA is third party administrator, and they generally help with employee benefit plans like health plans, 401(k) plans, and in my case, defined benefit plans. They do the compliance, the administrative pieces of those plans to ensure that the employer is dotting their I’s and crossing all their T’s.
Kirk Chisholm: So, you’re a third party administrator, so you primarily just focus on defined benefit plans. Is that all you do?
Brent Henningson: Yes, I exclusively focus on defined benefit plans. In some cases, if an employer has employees, they’ll couple the defined benefit with a 401(k) plan. If that’s the case, I’ll do sort of the umbrella work, making sure that the two plans interact and coordinate.
Kirk Chisholm: So, if you’re only doing defined benefit plans, maybe you could excuse the pun, define a defined benefit plan for us.
Brent Henningson: Absolutely. I’ll talk about it in the context of 401(k) [plans], because I think everyone’s familiar with those types of plans. So, when you have a 401(k), that’s a type of defined contribution plan. And the way that works is people put in money every year. And when they get to retirement age, they have a pot of money, but the amount is going to depend on how much money they’ve put in and what the market’s done. With a defined benefit plan. It’s actually the other way around, where you define the pot of money, essentially upfront. So, if somebody is 40, you would assign a target upfront and then every year you would have an actuary, somebody like me, who would calculate what contribution would be needed to attain that final goal.
Kirk Chisholm: So effectively, if I said, “Hey, I want to have $10 million in my defined benefit plan”, I could just define that and then contribute it?
Brent Henningson: Essentially, yes, [but] the limit right now is $2.9 million payable at [age] 62 ($3.4 million now). But it’s pretty common for somebody to define that maximum and then work towards that goal.
Kirk Chisholm: This is pretty cool, and I kind of want to talk about the differences between the 401(k) and the defined benefit. So, the defined benefit, just for clarity, that’s what a pension, right?
Brent Henningson: Yes, that’s another name for it.
Kirk Chisholm: Okay. Because I know that if you look back, historically speaking, pensions were a big part of retirement. And when did that change? Like what caused some of those changes? Maybe you can kind of talk about that because I think people have heard of pensions, but a lot of people don’t have them anymore.
Brent Henningson: So, pensions started at the end of the eighteen hundreds, as we became more industrialized to reward employees, and they ramped up in the forties and fifties. Because of some abuse with employers, there was legislation [passed] around protecting employees with regards to pensions. And so, some of that started to unravel pensions in a way. In other words, unravel the demand for employers to want to put them in. But then there were other things that happened. We had the market crashes in 2000 and 2008. That required employers to put in an enormous amount of money all at once. We had accounting standards that made it a little more onerous to record and more expensive from the corporate profitability standpoint. And all of these factors created this gradual shift from defined benefit to 401(k) plans because [401(k) plans are] just a lot easier for employers to have.
Kirk Chisholm: So, if you kind of look at this now, the larger employers from what I can tell, are pretty much doing away with defined benefit plans. I know some of them are even trying to…was it FedEx the one that just stopped, I think, the other day? Who just said we’re no longer contributing to it? So, do you see it? Let’s go back to this step and let’s talk about the differences between the defined benefit and the 401(k). What are some of the major differences between the two plans?
Brent Henningson: I’d say there’s three major differences. The first one is, and talking about it in the context of the small business, because that’s where I specialize. So, with a 401(k), if they have a profit sharing component, somebody can put in around $60,000 a year ($73,500 a year now). It’s a good chunk of change. And for most people, that’s plenty of money to contribute. But you have this small percentage of the population where that’s not enough or they would like to contribute more. And that’s where a defined benefit plan can be a really great alternative because the limits for a defined benefit can be $100,000 to $250,000+ per year. And so, it’s an enormous opportunity to make a tax-deductible contribution. So that’s the first difference. The second difference is with a 401(k) or SEP or profit sharing, every year, the employer can decide whether they want to make a contribution or not. And so, there’s a lot of flexibility with that discretion. And for a small business owner, that can be obviously an important thing because profits can vary from year to year. With a defined benefit plan, it’s a little bit different. When you put in a defined benefit plan, every year, at least in most years, you’re going to be required to put in something. It’s not going to be necessarily a fixed amount. There’s going to be a range of possibilities or a contribution range that you can contribute. But it is more of a commitment in the sense that you’re not going to say in a given year, “Yeah, I don’t feel like contributing, so I’m not going to”. And then the third difference is with a 401(k), usually the accounts are individual accounts. And so, each participant’s account is tracked in its own account, whereas with a defined benefit, the assets are pooled and then the benefits are [tracked] by somebody like me or a TPA.
Kirk Chisholm: So basically, if you had like a hundred people, they all have the same account, and it is all pooled together?
Brent Henningson: That’s right.
Kirk Chisholm: So, it sounds like the defined benefit plan is a good strategy for small business owners or people who are earning a good income. What are some typical industries where this plan might make sense?
Brent Henningson: It’s a pretty broad section of industry. The traditional users of defined benefit plans are the doctors, the dentists, and the attorneys. And so, there’s definitely a demand in those industries, mainly because they tend to [have] obviously a higher income and are smaller businesses without too many employees. It just makes sense for somebody like that. When I started this business, one thing that actually surprised me is just the number of people who are nontraditional users of defined benefit plans where there’s interest. And what I mean by that is those in what I’ll call the digital space. So, people who are doing things like YouTube stars or food blogs, or maybe they’re doing Facebook ads or any kind of digital marketing. I have quite a few clients in that space, and they tend to be younger than what the traditional user is. A lot of them are in their thirties or early forties and the thought there is, even though they can’t contribute as much as they would be able to if they waited until they were 55 or 60, they know they’re in an industry where the profits are good now, an industry that changes quite a bit, and it can change pretty quickly. And so, the thought is if they’re doing really well now, they’re making $500,000 or $1 million right now, why not put it in $100,000 or $200,000 today and continue doing that for 5 to 10 years and kind of take advantage of that tax savings?
Kirk Chisholm: That’s great. I know we have a lot of people from the health service sector listening to this show, so I’ve seen certainly a lot of interest over time to do that. But in regard to a plan like this, is it similar to like a 401(k) where you can just invest it in anything? Or what are some limitations? Or how should people look at that part of it?
Brent Henningson: There’s a lot of flexibility in what kind of investments someone can contribute or sort of invest the contributions into. Obviously, any marketable securities like stocks, bonds, ETFs, mutual funds, those are all fine. There are alternatives like real estate, more exotic things like art. Some of the limitations around those alternatives, though, is if somebody has employees, they need to make sure that they’re investing those assets in a way that they’re being a fiduciary and they’re doing it in the best interest of the participants. So, for example, if somebody had invested in a beach house in San Diego or something like that, and then as the owner of the company and the Trustee of those assets was using that property for family vacations. That wouldn’t be acceptable because it wouldn’t be in the best interest of the plan participants.
Kirk Chisholm: All right, so the owner of the company can’t go buy a sailboat and sail around the world on the employee pensions. Is that what you’re telling me?
Brent Henningson: Yes, exactly. Or buy some kind of art and then that art’s hanging on their wall at home and displayed to everybody. It has to be in the best interest of the plan participants.
Kirk Chisholm: What if they invite the plan participants over for like holidays and they had them to look at the art? Does that count?
Brent Henningson: That would be nice. But, yeah, probably not.
Kirk Chisholm: So, I don’t know if you have some examples that you’ve gone through. Obviously, no names, but just how this works and maybe some ways that people have been able to save a good amount of money.
Brent Henningson: One that comes to mind is a person who had a large payout of $5 million or $6 million, and they knew it was a one-time payment, and then there would be subsequent income earned, but it would be quite a bit less than that large amount. And this person was in their 60s, early 60s. Their spouse worked in the business, which is another kind of bonus because you can essentially double how much you can deduct. And so, for this particular person, we were able to say, based on your income, your spouse’s income, your age, that you’re close to retirement, and then based on the fact that you want to frontload contributions (put more in at the beginning with the idea of putting less in as you go), they were actually able to put in about $900,000 into their defined benefit plan, between that and the 401(k). That was an example of a home run, where they needed a big deduction, there was no other retirement vehicle that could get them this size of deduction but a defined benefit plan provided that solution.
Kirk Chisholm: Wow. I thought it was much lower. So, basically, there’s no number limit per year. It’s really just dependent upon how old they are and information like that, correct?
Brent Henningson: Yes, and that would be an extreme example. It would be hard to get a contribution much larger than that. It’s all in the regulations and guidelines, but that would be, like I say, a home run with them close to retirement, their spouse is an employee, and they really want to frontload that contribution stream.
Kirk Chisholm: You know, not everybody is a one-person business. Some people might have small businesses. You mentioned dentists, doctors, attorneys, maybe architects, people like that. People [who] make good money, but maybe have some employees. So, what are some rules that people can think about as they’re considering this type of thing for their business?
Brent Henningson: When you have employees, you’re required to cover them, or at least a portion of them under nondiscrimination regulations. And what those rules are for is making sure that if the owner is going to get a tax deduction, that they’re not just taking all the contributions and funneling it to themselves as the owner. So, they’re giving their employees something in exchange for that tax deduction. So, if they had employees, kind of a general rule of thumb is 8% to 10% of their staff payroll would be what it would cost them. As an example, if, let’s say they had a million dollars in payroll, it would cost them $80,000 to $100,000 in benefits. If they were able between them and their spouse, who could also be an employee, to save $250,000 or $300,000 in taxes, maybe that’s not such a big deal. So, it’s weighing the value of that tax deduction against the cost of providing those staff benefits.
Kirk Chisholm: It sounds like as a staff member, it would be nice to have this sort of plan. Are there ways that the employers can…do they have to offer this to everybody or are there certain caveats and carve-outs they can have so that it doesn’t have to be offered to every single employee?
Brent Henningson: So, if they’re not an employee, let’s say they’re an independent contractor, then they wouldn’t have to provide a benefit to them. And, obviously, they need to be a bona fide independent contractor to be excluded. If somebody is under 21, they also can be excluded. And then if they’re part-time, meaning they work fewer than 1,000 hours per year, they also could be excluded. There’s also a carve-out if someone’s part of a collectively bargained agreement. So, there are opportunities for carve-outs, but for those who don’t fall in those categories, they generally are going to need to cover those or at least a portion of those people.
Kirk Chisholm: So, you mentioned spouse too. So how does that work? Can you get twice the benefit if a spouse works in the business?
Brent Henningson: If it’s [only an] owner and spouse, then definitely. If there are employees involved, then sometimes the spouse can be used to reduce those staff contributions. And what I mean by that is by giving this spouse a smaller benefit, it helps pass the nondiscrimination testing. So, it’s trying to get to the employer’s objective of how much they can save, and at the same time, trying to minimize that overall cost, as they need to provide something to their employees. It’s balancing a lot of different factors to get to that result.
Kirk Chisholm: In terms of the defined benefit plan, so when can people take funds from that?
Brent Henningson: When you establish a plan, there are rules around what’s called permanency. It sounds a lot more scary than [it is]. They don’t have to be in existence forever. But what the IRS is trying to avoid is somebody putting in a plan, taking a huge tax deduction, and then immediately terminating that plan a year later. They’re trying to avoid, obviously, someone creating some kind of a tax gimmick. And so generally, if someone keeps the plan three to five years, from the IRS’ perspective, that’s going to satisfy the permanency rule. Once that plan is established, funded, and then after that three to five year period, it can be terminated. Then those funds can be rolled over into an IRA or to some other qualified plan, like a 401(k), if it allows rollovers, and then you’ll then be subject to that plan receiving those funds. So, it would be subject to the IRA rules, for example, with the 59-1/2 [requirement].
Kirk Chisholm: This sounds great. If I wanted to set up a defined benefit plan, what would I have to do? I just go down to my local broker-dealer and just set one up. How does this work?
Brent Henningson: Defined benefit plans are really specialized. It’s a lot different than setting up, let’s say, a Solo K or a SEP…those things can obviously be done by the business owner on their own a lot of times. With a defined benefit plan, it requires that you have an enrolled actuary certify the figures, and I’m an enrolled actuary. So, they would need to contact somebody who specializes in defined benefit plans. Typically, the first step is talking about what they’re trying to achieve. How much are they trying to get into the plan? Do they have employees? How long is their horizon? And then from there, it’s putting together an illustration to show them what that would look like in hard numbers. And then if it makes sense, then it’s obviously going through the steps to adopt and fund the plan.
Kirk Chisholm: I spent half my career working in a broker-dealer world. I’ll tell you that there’s not a lot of talk about defined benefit plans. It’s not the thing that they teach you over there. There’s nothing wrong with that. They’re trying to help, but I find that most advisors aren’t even familiar with this. They don’t know how it works. They don’t know how to do it. It just seems like it’s really complex. There’s a lot of things that we talk about on the show that you probably never have heard of. And part of the reason is the fact that a lot of advisors just don’t know. They’ve heard of pensions. They’ve heard defined benefit [and] cash balance plans. They’ve heard of all these things, but they’re not really familiar for many different reasons. So, if your advisor is not familiar with this, look around and talk to other TPAs like Brent that can probably help you with this, because I know I’ve learned a ton from working with Brent with plans that we do, and he’s extremely knowledgeable in the fact that this is the only type of business that he does. You’re an actuary was that take a week to get that?
Brent Henningson: I started working on these types of plans in 2001, and I got my actuarial credentials in 2008. So, for me, it took seven years. That’s kind of on the fast-end of the spectrum for somebody to be what’s called a Fellow of the Society of Actuaries. So, obviously, a lot of work, a big commitment, and there’s a lot of work that goes into understanding how these plans operate.
Kirk Chisholm: I say that in jest because I know how hard it is to be an actuary and pass [those tests]. I’ve had a few people try to explain it to me. And I was like, “Why would people ever want to go through that? That just sounds painful.” So, this has been awesome. I’m glad to have you on the show. I’m glad we’re able to share your knowledge with a lot of people here as listeners, because I know this is one of those tax loopholes of the rich that I really want to kind of get the word out there about, you know, we’ve had a few people on the past talk about some other ones and we’ll have some others on the future. But for people really high income earners that are looking to put money away for retirement, this is a really interesting vehicle to explore as a way to exceed the 401(k) limits that most of us have with our annual contributions. Any final thoughts on those things we haven’t talked about, Brent, you think we should know?
Brent Henningson: I think you hit it right on the head a second ago [about] when does it make sense to explore this type of plan? To keep it really simple, I would say that if you’re being limited by your current retirement plan in the sense of how much you can put in. So, if you want to put in more than the $60,000 that a SEP or 401(k) allows ($66,000 and $73,500 now, respectively), if your compensation is such that there’s a compensation limit that’s coming into play, if you’re being limited for any reason on those type of plans, that’s where it’s at least worth asking the question if this plan makes sense for you.
Kirk Chisholm: Great. Well, Brent, I really appreciate you coming on the show here and sharing the knowledge with our listeners. And where can people find more about you?
Brent Henningson: They can go to my website, which is saberpension.com. It has a pension calculator where people can figure out how much they could contribute per year. There are case studies, so there’s a lot of good information on there.
Kirk Chisholm: Well, thanks for coming on. The show will certainly put a lot of this information in the show notes, so people can learn more about this really interesting topic. Thanks again for coming on the show, Brent.
Brent Henningson: Thanks, Kirk. I appreciate you having me.
Kirk Chisholm: Wow, that was a great interview with Brent Henningson, and I’m really glad we had him on the show, because I know Brent’s a real expert in this area and I’m always leaning on him for his expertise when I come across this in my practice.
Aired June 16, 2020. Listen to the full show here.
The transcript for this Defined Benefit Plan podcast is not provided. However, the show host discusses with us the best form of payment (e.g., lump sum, monthly annuity for life, monthly annuity with spousal survivor benefit) for someone to select. Thus, the podcast is from the perspective of a plan participant rather than from the business owner’s standpoint.
Aired July 18, 2020. Listen to the full show here.
The transcript for this Defined Benefit Plan podcast is not provided. However, the show host discusses with us various elements of Defined Benefit Plans for business owners. Note that many of the questions are similar to the first two podcasts we have featured.