If no, I wouldn’t blame you. Believe it or not, most financial advisors and accountants don’t even know what they are — or at least how to utilize them properly.
Our friends at Emparion have helped several of our clients with structuring these defined benefit plans within some of our overarching tax planning strategies. For self-employed individuals in the higher tax brackets, they can be a game-changer. With their permission, I wanted to share an email that I received from them detailing some scenarios where a business owner might find them helpful.
Benefit #1: Stay below the pass through 20% deduction threshold
With the 2017 tax reform, there are significant tax savings to qualified business owners. Pass-through businesses can now take a 20% deduction from qualified business income. However, the rule will not apply equally to all business owners. It restricts certain service businesses like consultants, accountants, physicians or attorneys if their taxable income is over a specified limit.
Utilizing a defined benefit plan will often allow a business owner to get below the specified threshold. So not only does it save you taxes on the contribution, it preserves the 20% business deduction. Overall, this could result in tax savings greater than 50% of the contribution.
Benefit #2: Combine with other retirement plans
Another defined benefit plan advantage is that they can be combined with other plans like a 401(k) and a profit-sharing plan that can maximize contributions and tax deductions.
In contrast, 401(k) plans allow a contribution up to $56,000, plus an extra $6,000 for individuals 50 years and older. Combining a defined benefit plan with a 401(k) and profit-sharing plan can result in even larger tax-deductible contributions.
Benefit #3: Maximizing contribution = maximizing benefits
Contributions under a defined benefit plan can be as high as $300,000 depending on age and income. Contribution limits increase as employees approach retirement. Any contributions will be deducted from taxable income and result in lower taxes. The funds in the account grow tax-deferred.
Defined benefit plans are a highly effective tool for tax planning. However, make sure the business owner is educated on the pros and cons of the plans. In addition, adequate cash flow should be available to fund plan contributions. A third-party administrator should be used to ensure that administrative tasks are accomplished.