By Ed McClure, CFP®, PPC®
Funding a business owner’s personal retirement plan is one of the most common challenges we work through with small companies. A defined benefit plan (DBP) offers unique ways for some business owners to drastically increase the rate at which they fund their retirement. A DBP won’t work in every case, as various testing criteria limit the pool of employers. But for business owners whose companies fit the criteria, the tax benefits are enormous. You generally need to give a little bit more to your employees to meet the testing requirements, and although there’s no fixed size limit, the numbers tend not to work as well for large companies.
Who Can Use a DBP?
A DBP is ideal for small businesses that are established and growing, with older owners and younger employees. As gross revenues increase over the years, tax problems grow more complex. Owners whose personal income is taxed in the higher brackets should consider the possibility of adding a DBP. Age is an important factor. If the owner is under age 40 or has a large number of employees, this plan may not be a good fit (especially if some of those employees are older than the owner).
The Difference a DBP Makes
The main benefit of a DBP is that it allows a business owner to put away a lot more money, tax-deferred, than what would otherwise be allowed through other retirement plans like a 401(k) or IRA. With a DBP, we have seen some business owners able to save $100,000, $200,000, or $300,000 per year, depending on their age and salary. The closer you are to age 65 and the more you show as salary, the more you can put away with a DBP.
One Example of a DBP
Let’s look at a live example to see how the numbers work. In 2020, we worked with a small company with two owners, who initially were contributing a combined total of $45,000 per year to their retirement. By adding a DBP to the mix, we were able to increase that number to just over $350,000 for 2021. The owners will receive a tax deferral on the full amount. A few years ago, we worked with another small company owned by a husband-and-wife team with three employees. By giving employees a small amount on the DBP, we were able to give the owners a lot more. Both owners are located in California and were paying federal tax at the top tax rate of 37%. They are able to realize a total of 47% tax savings when you factor in the 37% federal tax and 10% California state tax. That translates to a reduction of their current-year tax liability of over $160,000. These numbers are not unusual for the right businesses.
We’re Here to Help
A DBP is not the only option for business owners looking to fund their retirement. This is an example of one way business owners sometimes miss out on opportunities due to not taking advantage of the right strategies early enough. If you own a business and would like to explore the possibility of a DBP or investigate which other options might work, give me a call at (760) 607-0611 or email [email protected] to set up a consultation.
About Ed
Ed McClure is a CERTIFIED FINANCIAL PLANNER™ practitioner, Professional Plan Consultant® (PPC®), and founder of McClure Wealth Management. With over 25 years of experience, Ed works with business owners who want to maximize their retirement plan benefits, businesses that need help setting up and managing a 401(k) for their employees, and families who want guidance while planning their futures. He is known for simplifying complicated and intimidating topics and making wealth management concepts easy for others to remember and understand.
Ed has established himself as a trusted resource for business owners and individuals, and his mission is to help his clients achieve the financial independence and well-being they deserve so they can give their time and energy to the people and things they love. He has a bachelor’s degree in finance from the University of Illinois. In his spare time, Ed conducts financial workshops for the Just In Time for Foster Youth organization, which helps equip young men and women as they come out of the foster care system. He also loves to travel and spend time with his favorite people. To learn more about Ed, connect with him on LinkedIn.
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