Fully Funded Retirement in 10 Years: A DB Plan for Now

Your small business clients are faced with the increasing likelihood of higher taxes in 2013 and beyond; those aiming to reduce the slope of the fiscal cliff next year will want to take a closer look at the benefits of a defined benefit plan.

While most small business owners create defined contribution plans to save for retirement, the defined benefit plan allows for considerably higher annual contributions. Because taxpayers are permitted to contribute up to $200,000 for 2012 and $205,000 in 2013, the defined benefit plan presents a planning opportunity that may be too good for many of your small business clients to pass up. Contribution limits this high can allow them to completely fund their retirement accounts in under a decade—all with pre-tax dollars.

Defined Benefit Plan Basics

The defined benefit plan is essentially a retirement plan that provides for a fixed monthly retirement benefit, which is usually based on a percentage of the client’s current income.

The fixed benefit level will help the client determine how much he should add to the plan each year, but the primary advantage of the defined benefit plan is that the client can put away upwards of $200,000 a year for 2012 and $205,000 for 2013. The contribution levels for these plans are determined based on the client’s age; therefore, the anticipated length of time before he will retire.

While the generous contribution limit alone can provide the small business owner with a powerful incentive to create a defined benefit plan, with all eyes focused on today’s fiscal cliff negotiations, these plans become even more attractive. Contributions to a defined benefit plan can be deducted as an ordinary and necessary business expense to reduce the taxable income of your client’s small business.

Which Clients Are Right for a DB Plan?

A defined benefit plan is typically best suited for the client who is able to contribute at least $50,000 annually toward the plan. Because there are fees and expenses associated with maintaining the plan, clients wishing to contribute less would be better off forming a less expensive defined contribution plan. While the contribution limits for a traditional 401(k) or IRA are much lower ($17,500 plus $5,500 in catch-up contributions for those age 55 and older in 2013), the defined benefit plan fees can offset the tax benefits if actual contribution levels are not high enough.

Additionally, because the defined benefit plan nondiscrimination rules require that the plan be made available to all of the client’s employees, these types of plans are best suited for clients who have very few key employees or who run a small family business.

Further, because the defined benefit plan rules require the client to meet specific funding levels each year, the plans are best suited for those planning to retire between five and ten years in the future. Once formed, the defined benefit plan must be maintained for at least five years before the client can roll the funds over into a traditional retirement account.

While the defined benefit plan is not the magic solution for every client, it can provide a unique opportunity for those high-income small business owners looking to reduce the sting of possible year-end tax hikes—with the added bonus of creating a substantial retirement nest egg in just a few years.

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We invite you to visit the AdvisorOne Fiscal Cliff landing page for up-to-date coverage on the fiscal cliff negotiations and the implications of going over the cliff.

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