Rohit Punyani, Co-Founder • Dec 12, 2023
Exploring defined benefit plans can be complex and often leave business owners pondering a crucial question: “What options are available for reducing taxes while planning for retirement as a business owner?” In the complex world of taxes, taking the right steps is crucial.
Define benefit plans, whether it's a defined contribution plan or a fully insured pension plan, which are pre-tax deductions that lower taxable income to the entity utilizing the plan.
A Hypothetical Example
For example, in a typical pass-through structure like an LLC taxed as a partnership, if each partner receives a K-1 distribution of $200,000 after all expenses, that amount is taxable to the individual. However, by introducing and funding either a cash balance plan or a 412(E)(3) plan the partners can take that same cash and fund a plan. This will give them a lower taxable income and a current deduction - this is typically a $0.40 on the dollar reduction in your current tax liability and each year the plan is funded.
Curiosity might have you asking, "What's the catch? Can I truly get my money out of a defined benefit plan?" The answer is "Yes!"
Upon plan termination, each employee rolls their proportional share into an IRA. Subsequently, standard IRA withdrawal rules come into play:
Finally, it's important to note that after ordinary income is withdrawn from an IRA, deductions may also apply for Social Security, Medicare, potential state income tax, Medicaid, and provisional income.
Sophisticated users of defined benefit plans often consider utilizing life insurance in the plan. Due to the steady, consistent nature of life insurance - the tax-free, risk-free, creditor-protected, and bankruptcy-remote features - and the unique one-time-in-kind redemption for life insurance out of a plan, life insurance is a sophisticated, popular choice to fund a portion of a plan.
Life insurance inside of a DB plan, and only life insurance, can be pulled out of the plan without triggering taxes.
Once outside of the plan, life insurance will continue to grow tax-free and also provide both liquidity and state planning benefits for business owners. Fusion Strategies has deep expertise in designing managing and exiting defined benefit plans both cash balance and 412(E)(3)
Alright, let's transition from the details of life insurance in your defined benefit plan to the practical side of things for small business owners. Wondering how to make it work for your business? Let's dive into the steps you'll need to take. Wondering how to make it work for your business? Let's dive into the steps you'll need to take
Leveraging the full potential of a defined benefit plan for your small business involves a strategic and streamlined process. Here's your roadmap:
What does a two-person, owner, and employee, plan look like?
Let’s explore the unique dynamics of a two-person plan, featuring both the owner and an employee. Here's a glimpse into the key aspects:
A Hypothetical Example
Now, let's delve into a hypothetical scenario involving a 60-year-old owner and a 35-year-old employee, both earning around $300,000 annually. They share a common interest in a cash balance plan, aiming for the maximum deduction:
It's important to note that these figures significantly surpass standard 401(k) salary deferrals.
💡Keep in mind that these represent the maximum contribution amounts, and adjustments can be made based on the business owner's current cash flow and preferences for plan funding. This two-person plan presents an opportunity for tailored contributions, ensuring both parties benefit optimally from their retirement strategy.
Now that you've gained a comprehensive understanding of the intricacies surrounding the taxation of defined benefit plans, the next step is to turn this knowledge into a strategic advantage for your business.
At Fusion Strategies, we specialize in navigating the complexities of defined benefit plans, offering solutions tailored to your unique business needs. With our deep expertise in designing, managing, and exiting both cash balance and 412(E)(3) plans, Fusion Strategies is your trusted partner in optimizing your retirement strategy. Whether you're exploring the potential tax benefits, contemplating the inclusion of life insurance, or considering the intricacies of a two-person plan, our team is here to guide you every step of the way.
If you're eager to explore whether a defined benefit plan is the right fit for your business, Fusion Strategies is here to guide you.
Contact Fusion Strategies today, and let's embark on a journey to secure your financial future.
With 40+ years of financial services experience, we create tailor-made "Banking Style" life insurance contacts
Arlington, VA
New Orleans, LA