Retirement Planning: What is the Defined Benefit Plan that can Help You Save $100’s of $1,000’s

Troy Sharpe: Did you know that there are retirement plans out there that can allow you to save hundreds of thousands of dollars? You don’t have to be limited to just your 401(k) maximum contribution. If you’re an independent contractor, a sole proprietor or a small business owner, this video can help you understand how to potentially save hundreds of thousands of dollars pretax into your retirement account.
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Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, certified tax specialist, certified financial planner professional, and host of The Retirement Income Show. Okay, we’re going to talk about defined-benefit plans. Most of you are familiar with what is known as a defined-contribution plan. That’s your 401(k), your 403(b), your SEP, your Simple, those are plans where you can make a defined contribution into and there are annual limits.

Defined-benefit is the old pension plans essentially. Here in Houston, we have a lot of clients that work for the oil and gas companies, engineers, et cetera. Oftentimes when they retire, they not only have their 401(k), a defined-contribution plan, but they also have a pension or a lump sum that they can roll over into an IRA. That is a defined-benefit plan. Now it’s important to understand the difference. I’m not going to get into too much detail here.

My goal is to educate you that these plans exist. Oftentimes, we’ll set them up for physicians, we’ll set them up for real estate agents that are able to 1099 with a brokerage firm. Maybe you’re a small business owner. Typically, these are going to work better when you don’t have a massive amount of employees because you have to fund their plans as well. Although granted, there are age restrictions, there are funding requirements. Too complex for me to get into everything here, but I want you to know that if you are in one of these categories that I’m talking about, this could very much apply to your situation.

Defined-benefit plans, essentially, instead of having a defined -contribution that we can put into it, the IRS creates a formula that says, we have to fund it to achieve some type of defined-benefit in the future. These are going to typically be based on your age, your income, and also your years of service at the company. I want to look at a couple examples here and lets that if you’re in one of these categories, this is something you could definitely look into more.

We help people set these plans up all the time. If you want to reach out to us, great. If you want to reach out to your advisor or go online, do some shopping, figure it out. I just want you to be aware that these strategies are 100% above board. They’ve been around for forever in this country. Although, we’ve shifted from the defined-benefit plan model to the defined-contribution plan model, which is going from pensions, the way it used to be for your parents and grandparents, to 401(k)s.

This example, we’re going to look at a 52-year-old small business owner and see how much- in this example, they’re making $500,000 a year, how much they can put into their defined-benefit plan. We’re also going to look at though a 401(k) and a profit-sharing contribution that could increase all of those benefits. Tim Sample, he’s just a sample person we’ve made up here, $500,000 of compensation. If you want to know what your compensation is to qualify for this, because there are funding limitations, based on, you want to look at your schedule C income on your tax return. If you’re self-employed, a sole proprietor, that’s where you’re going to get this number. If you are an LLC or a small business owner, it’s going to be a little bit different location on the tax return.
$500,000 of compensation, birthday 1/1/1969, so 52 years old as we’re recording this video. The estimated defined-benefit contribution that they can make is $216,000. That’s 216 to put in the defined-benefit plan, 100% deduction of that amount this tax year. Had an estimated 37% tax rate, that’s a tax savings today of $79,957. If this person was 57, or 59, or 62, they would be able to put a larger amount into the defined-benefit plan because the defined-benefit again, we are funding it today to achieve some type of defined-benefit in the future, so when you’re older, you have a lesser horizon to achieve that funding level or funding amount. Not only that, your life expectancy is also less as well when you’re older.

The way the formulas work, the older you are, the more income you make, the longer you’ve been at your company, essentially, the larger amount you can contribute. Now, if this person wanted to also do a 401(k) deferral because you can have a defined-benefit plan and a 401(k), 216 is a defined-benefit. You could put a maximum $26,000 inside the 401(k), plus with an employer 6% contribution, you can get up to $257,000 you can deduct today, get into retirement accounts for an estimated first-year tax savings of $95,164.

These plans are not just for a one-time deduction. We need to be working, we need to plan on making contributions into this plan over time. There’s an actuary that needs to be involved as far as calculating how much you can put in, what is the funding level of the plan. You don’t want it to be overfunded, you don’t want it to be underfunded. These are complex retirement plan structures that the IRS is going to scrutinize to make sure that you do not over or underfund it and get into a situation where you’re essentially trying to violate the tax code.

It doesn’t mean they’re illegal, it doesn’t mean anything like that. They’re not even really, as far as I’m aware, high on the IRS’ list for potential schemes. It’s not like a captive insurance company, it’s not like having offshore companies, or having a Puerto Rican entity, those things are much more on the IRS’ radar. This has been around for 50, 60, 70, 80 years in this country. This is nothing new.

Some people do of course take advantage of them, but understand, if you do it right, you work with a professional, there’s a third-party company that does these. We help clients set them up. We’ll manage the money inside them, help with building a retirement plan and a tax strategy, but we still need a third-party firms that are experts in these plans to make sure they’re utilized correctly. You have to file forms every single year or 5500, you have to have a valuation.

They’re not that expensive, even though I’m making them sound like there’s a lot to do. It’s just a very specialized part of the tax code. There are companies that specialize this, and we want to hire specialists to help us achieve our goals.

Okay, comparatively speaking, this particular person, they could do a Simple IRA or a SEP IRA, or they could have a 401(k) with a profit-sharing plan. These are probably better solutions if this is the maximum you want to save for retirement. If you’re doing really well, $400,000, $500,000, $600,000, $700,000 a year in profit or income, this could be a way to really supercharge the amount of savings that you put into your plan, reduce the taxes you pay today, and get yourself well on a path to a more secure retirement.

In summary, I want you to simply be aware that defined-benefit plans exist. They are a bit complex. We need to hire third-party firms to help administer these types of plans, file the appropriate forms annually, do the actual royal valuations. What they calculate is we’re putting money in today to fund some type of defined-benefit in the future. These differ from 401(k) plans, in the sense that 401(k) plans are defined-contribution plans, where you can put in a defined-contribution up to an annual limit based on your age.

Ton of tax savings potentially available, but these are for independent contractors, sole proprietors, small business owners. If you’re a W2 employee of another entity, you cannot simply set up your own defined-benefit plan. A lot of times, these are physicians or doctors, dentists, real estate agents, anyone who has their own small business or 1099s as an independent contractor, this may be a very, very viable solution for you.

If you meet the qualifications that I’ve laid out here, and this is intriguing to you, and you’d like to learn more, feel free to reach out to us, gives us a call. Let’s talk about it, see if this is suitable for you. We can point you in the right direction to a third party to help administer it while partnering with us. Of course, you can always reach out to your local financial advisor. I would just make sure that they have a working knowledge of how these plans work because there is some ongoing work between you, the advisor, and the third- party administer.

All right, thanks for watching today’s video. I hope this was helpful for you. Comment down below, subscribe to the channel. If you hit that bell icon, you’ll be notified when we upload new content, so we can keep you more connected to your money.
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