For many business owners, the reality is that you may be closer to retirement age but possibly further away from your retirement savings goals.
And with millions of self-employed Americans, according to the 2023 Current Population Survey,..many business owners are in charge of generating their own retirement savings.
The good news is, with an experienced professional on your side at Consolidated Planning, business owners can find the right strategy to accelerate their retirement savings. Here at CP, we’ve been working with business owners for decades to help protect, grow, and ultimately exit their business on their terms.
A potential plan of choice for business owners to “catch up,” if you will, is a defined benefit plan. Here we will help you understand what a defined benefit plan is, what those benefits and tax savings might look like for you, to help you decide if a defined benefit plan is right for your business goals.
What Is A Defined Benefit Plan?
While a great deal of business owners tend to lean towards a 401(k) profit sharing plan, this option has an inability to guarantee a secure benefit at retirement. A defined-benefit plan may provide a guaranteed benefit at retirement and allow for accelerated retirement funding for those nearing retirement. Therefore, allowing successful business owners to plan to catch up and accelerate those retirement savings.
The key characteristics of a defined-benefit plan include:
- Predictable benefits based on a formula
- Business owner responsibility to fund
- No investment risk to employees
- Lifetime benefits
The accumulated account balance in the Deferred Benefit Plan may be used to provide a guaranteed retirement income stream, one that the business owner (and spouse or significant other) may not outlive. After the passage of the Tax Cuts and Jobs Act (TCJA), defined-benefit plans remain a powerful planning tool that business owners can employ to enhance their economic security and prepare for a more predictable retirement.
Doesn’t that sound nice?
How Business Owners Can Save Money With The Right Defined-Benefit Plan
Save money. Say no more. While cost saving opportunities depend on various factors and are not always straightforward, the right plan can boast huge benefits to business owners.
#1 Tax Deductions
Employers can typically deduct their contributions to a defined benefit plan as a business expense, which reduces their taxable income. Yes, reducing your taxable income for the current year.
This can result in lower business income taxes, leading to cost savings. Removing what otherwise would be taxable income into your pocket on a tax-deductible basis.
#2 Attracting and Retaining Talent
Especially in today’s landscape, finding AND keeping good employees is no small task.
Offering a defined benefit plan can be a valuable tool for attracting and retaining highly skilled and experienced employees. This can result in cost savings by reducing turnover and the costs associated with hiring and training new employees.
This can also be used to perform double duty by assisting with your exit strategy.
#3 Stable Workforce
And because it can be so daunting to attract the right talent, retaining that talent is essential to the success of your business.
The promise of a fixed retirement income can encourage employees to stay with the company for the long term, which can lead to a more stable and experienced workforce. This stability can save businesses money by reducing the costs of recruitment, onboarding, and training.
#4 Long-Term Cost Predictability
Anything that can make your job as a business owner more predictable is worth considering. With a defined benefit plan, business owners know in advance how much they need to contribute to meet future pension obligations. This predictability can help with financial planning and budgeting, reducing the risk of unexpected financial liabilities.
#5 Tax Benefits for Owners
In some cases, business owners who are also employees of their companies can benefit from defined benefit plans by accumulating substantial retirement savings in a tax-advantaged manner.
The plans can allow them to contribute more than they could in a defined contribution plan, which can reduce their current taxable income and potentially grow their retirement savings faster. And in some cases, can even help business owners “catch up,” if they have neglected their own personal retirement goals. Playing catch up is far more common amongst business owners with so much to worry about day in and day out.
#6 Flexibility in Contributions
While defined benefit plans require employers to meet certain funding requirements to provide the promised benefits, they often allow some flexibility in HOW contributions are made. Business owners can adjust their contributions based on their financial situation and the plan’s funding requirements, potentially reducing costs during more lean years.
So, what are your options when it comes to choosing a defined-benefit plan?
Understanding Your Options For A Defined Benefit Plan
Choosing an option for your defined benefit plan depends on the business owner’s specific goals and objectives. Generally speaking, there are three types of defined benefit plans to choose from:
- Traditional
- Cash balance, and
- Fully insured
While all defined-benefit plans are required to offer payment of an employee’s benefit in the form of a series of payments for life. There is a difference between the three which depends on your preference for funding the benefit and market volatility.
The maximum single life annuity that can be funded for in 2023 is $265,000, increasing in 2024 to $275,000. This means you are funding for a lump sum amount at retirement age to provide for a single life annuity. The necessary contributions are being made, with various assumptions, to accumulate approximately $3 million dollars. You can see the power of this approach versus the 401(k) plan.
Traditional Defined-Benefit Plan
The traditional defined-benefit and fully insured plans define an employee’s benefit as a series of monthly payments for life to begin at retirement, but cash-balance plans define the benefit in terms of a stated account balance. These accounts are often referred to as hypothetical accounts because they do not reflect ACTUAL contributions to an account or actual gains and losses allocable to the account.
Cash-Balance Defined-Benefit Plan
A cash-balance plan is considered a hybrid defined-benefit plan that provides guaranteed benefits to employees. It resembles a profit-sharing account because it
provides benefits to employees that they can review, which are referred to as the hypothetical account balance. The hypothetical account is a great way to communicate the benefit in the plan. There is actually no individual account balance, as plan assets are commingled and generally directed by the plan’s fiduciary. Contributions to the hypothetical account are typically based on a percentage of compensation.
For business owners, caution must be taken with this option as sufficient cash must be available to pay out the account balance. The trust assets need to have sufficient cash to pay out that account balance.
With plan assets invested in a mix of securities, the assets of the trust will fluctuate with gains and losses in any given year. Ideally, the trust assets should always equal, or exceed, the hypothetical accounts.
What IS very appealing to business owners here is the ability to better control the cost of the retirement plan. Additionally, with the right professional helping you design your plan, your plan may help optimize your contributions as the business owner.
Further helping to fuel your retirement goals.
Fully Insured Defined-Benefit Plan
Compared to the other defined-benefit plans, the full insured plan has several additional benefits in providing retirement advantages. One of which includes those who are more risk averse. In a more volatile market, there can be no over-funding or under-funding.
However, business owners need to be cautious with this option as the purpose of offering a defined-benefit plan is to assure that the normal retirement benefit will be guaranteed to be payable to the participant at retirement regardless of the investment performance of the plan assets.
But, for the business owner, contributions here will not necessarily fluctuate from year to year since the funds are not subject to normal market fluctuations. This plan further allows the business owner to extend predictability to a certain extent.
Is A Defined-Benefit Plan Right For Your Business?
When it comes to being a business owner – there is not a one size fits all approach. And because of that, it can be hard to know what is right for your business.
However, contributions to defined-benefit plans are generally tax deductible, reducing ordinary income, while subsequent earnings on these contributions grow on a tax deferred basis, the federal and state income tax savings can be quite impressive for business owners.
A defined-benefit plan may also be useful in preventing those business owners who are nearing or over the threshold starting point of $364,200 (married filing jointly in 2023, increasing to $383,900 in 2024) to reduce their incomes in order to qualify for the Section 199A deduction.
It’s important to note that defined benefit plans can also come with significant administrative and regulatory requirements, and business owners may need to seek professional guidance to ensure compliance with pension laws and regulations.
This is where your dedicated experienced professional at Consolidated Planning comes in. To learn more about the costs and benefits of a defined-benefit plan and how they may vary, reach out to a team member to understand how a plan of this caliber is implemented.
Exp. 11/2025 2023-164318
Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
This material contains the current opinions of Ernie Guerriero and Consolidated Planning only. These are not the opinions of Park Avenue Securities, Guardian, or its subsidiaries.
