The Perfect Retirement Plan for Business Owners Over 45

Of course, you don’t like paying income taxes. However, navigating your way through ERISA, Department of Labor and Internal Revenue Service rules and regulations for retirement plans can be tedious, if not dangerous.  The key for all business owners is finding the plan that provides the maximum deductions with the minimum contributions for the employees.

The main problem is that the plans that allow for very large (over $50,000) deductions for the owner usually require significant contributions on behalf of the employees as well.  A basic 401(k) offers very little in the way of annual deductions and there are “top-hat” or “top-heavy” rules that threaten your deductions if a certain percentage of the employees don’t participate.

Generally, a defined benefit plan allows for much bigger deductions for business owners who are getting a late start on the retirement planning (or who have lost their plan assets in a divorce or other lawsuit).  For example, a 50 year business owner who makes over $170,000 per year and is just starting to make contributions to a newly- formed defined benefit plan, may make up to $69,500 of tax-deductible contributions per year.  How is this possible?

The Basics of Defined Benefit Plans

Defined Contribution Plans, like 401(k) and profit sharing plans, restrict your contributions but do not put a cap on the potential growth of the plan assets.  Of course, every business owner will have a different amount available in his/her plan at retirement, which depends on the investment results.  Further, there is no guarantee on how much will be available for retirement unless the investments inside the plan are all in guaranteed, fixed investments.

In a defined benefit plan, the amount you will retire with (at a predetermined age) is set based on your salary and year of retirement.  Then, under IRS approved and actuarially reviewed assumption, you are allowed to put money away on a tax-deductible basis to achieve that goal.  Of course, if the plan accounts for 5% growth in your investments and you only get 3%, there will be much less available in retirement to make up for this risk, the government allows you to alter the amount each year, based on the returns on the investments in the previous year.  There is also a possibility that your investments may exceed the assumed rate of return. If that happens, you will not be allowed to deduct as much in annual contributions in future years.  Because of the annual costs of the actuarial review, defined benefit plans are more costly than the defined contribution plan alternatives.  However, if you are over the age of 50 and don’t have much in the way of retirement plan savings, the tax-deductions will more than offset the additional cost of approximately $1,000 per year – not to mention you will be able to save more for your retirement.

A Variation on the Theme – how to deduct $200,000 per year

A 412(I) plan is a type of defined benefit plan.  This plan works almost exactly the same way as the typical defined benefit plan.  However, there is one major twist – the benefit in retirement is Guaranteed!  That’s right.  If you construct a 412(I) plan to give you a monthly benefit of $15,000 per month in retirement, it is guaranteed to be at least that high.  How is this done?

The 412(I) plan purchases a blend of annuities and permanent life insurance from insurance companies that offer guarantees of 2% or 3%.  With a 2% or 3% return guaranteed, the IRS allows you to use the 2% or 3% return in your calculation of future value of the plan.  Because the regular defined benefit plans assume a nonguaranteed return of 5%-7% when determining the amount of tax-deductible contributions the owner can make and the 419(I) plans use a much lower 2%-3% return, the 412(I) plans allow for significantly more in tax-deductible contributions annually.  For example, it is possible for the same 50-year-old business owner mentioned before to make contributions of $85,000 or more per year in a 412(I) plan.

Why would I want lower returns? 

You are not getting lower returns.  You are just guaranteed a lower amount – with the upside potential of greater returns.  The annuities in the 412(I) plan may still give you 5%-7% or more per year.  In fact, the 412(I) plan’s investments will likely give you much more than the 2%-3%.  However, we only have to use the guaranteed amount in our actuarial calculation.  This is what allows some 60-65 year old business owners to make $250,000 in tax-deductible contributions per year into a 412(I) plan.

You are saving significant income taxes in your prime earning years, you are getting a guaranteed return on your investment, you have the upside of the market, and you do NOT have to have any employees to start a 412(I) plan.  We find that many anesthesiologists either work for themselves or work in a larger group and have no employees.  In the latter case, we generally recommend making your own individual Professional Corporation (PC) or Professional Association (PA) a partner or member of the larger group.  Then, you can create the retirement plan that best fits your individual needs.

If you would like us to review your situation and recommend a strategy that best meets your goals, or if you want us to review your existing plan to see if we can help you reduce your annual fees or investment expenses, please do not hesitate to contact me or a local financial planner or life insurance agent.