Defined Benefit Plans Offer Numerous Perks
Wouldn’t you like the opportunity to put away $150,000 in pension savings at a cost of only $91,850? It’s important to understand that because of the additional savings from your tax deduction the government is essentially funding the remaining $58,150 of that annual contribution. Imagine how much revenue you’d have to generate to earn a $58,150 profit — that’s a lot of sales. Instead, you contributed $58,150 toward your retirement without working any additional hours. In addition, you are contributing $17,000 to your employees’ pensions without any cash outlay.
Defined benefit plans generally reward long-service employees and can be a real loyalty builder. Workers don’t “earn” the right to keep the entire balance of their plan until they have been with your business for a specific amount of time. Since the benefit value reaches its highest level as employees approach retirement, the plan minimizes payouts to workers who leave the company prior to retirement. For example, if an employee leaves after, say, two years, the vesting schedule may only allow him or her to receive 40% of the balance. Where does the other 60% go? It typically reverts back to the remaining plan participants, and is distributed according to their plan ownership ratios. Or, the small business owner has the option of applying those funds to future plan contributions. That means more cash in your pocket without additional outlay.
Ever wonder why OJ Simpson still lives a nice lifestyle when he reportedly lost everything in his civil suit? Well, an advisor was surely smart enough to put money away for him in a plan such as this because the monies are protected from lawsuits. For people in high-risk businesses such as construction this is an added benefit not be taken lightly.
Enlist the Pros
I find that scenarios such as the above example surprise some prospective clients. They may have defined benefit plans, but their plan implementation isn’t nearly as impressive. They are considering eliminating the program, and rightly so. Brokerage firms, insurance companies, investment advisory and even CPA firms frequently use “off-the-shelf” or prototype defined benefit plans, which have been adopted for general or mass use, and just “plug” in numbers without customizing the plan to the particular employer and his or her employees. Unfortunately, business owners don’t realize their plan could be performing better, as my example above demonstrates. In these prototype plans I find the generic contribution levels are typically low — around the mid-five figures. Even more disturbing is the fact that many professionals utilizing such “off-the-shelf” plans don’t understand them, or fail to recognize they are not serving their clients as well as they could with a customized defined benefit plan. In contrast, every plan that Zdenek Financial Planning recommends is approved individually by the IRS and by the plan administrator.
Unlike defined contribution plans, these plans can be somewhat complicated to set up and maintain. So, it’s important to enlist the right pros. Use a great CPA who understands your current tax situation and can look ahead to your financial future. Hire an actuary to run calculations and valuations on a regular basis to ensure the required investments are being made and the promised benefits are adequately funded. And rely on an investment advisor who has a proven track record of providing acceptable investment returns to keep you and your employees on track. Your CPA can also make sure the Pension Benefit Guaranty Corporation (PBGC), a federal agency, insures the plan benefits, and makes sure all required paper work is handled and the annual premiums are paid. While these financial pros may sound costly, their fees can be minor compared to the wealth you can build quickly for yourself and your employees all while relieving a substantial tax burden for your business.
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Guy McPhail, CPA, CFP, is president of Zdenek Financial Planning, LLC. www.zdenek.com
