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Understanding your Self Employed Defined Benefit Pension Plan options in 2020

Understanding your Self-Employed

Defined Benefit Plan options in 2020

If you are self-employed, earning consistent and significant income, a Defined Benefit Plan could be a good fit. Having a Defined Benefit plan significantly reduces your taxes while simultaneously helping you meet your retirement savings goals.  Detailed below are major factors to consider when choosing a Defined Benefit Pension Plan for yourself and your business.

Large Tax-Deductible Contributions

What sets the Defined Benefit Plan apart is that contribution limits are significantly higher than more common retirement options. Because the defined benefit annual contribution is based on a future desired payout, (limits are $230,000 for 2020) and not a hard dollar limit, the Defined Benefit Plan can allow self-employed individuals to contribute up to $250,000+ per year. The older you are or closer to retirement the higher your allowable contributions range will be. 

Flexibility in Contributions

In a Defined Benefit Plan, business owners are able to adjust contribution amounts year by year as long as it falls within the allowable contribution ranges. This allows the business owner to use current years’ cash flow and taxable income when deciding contribution amounts. This adjustable feature grants the flexibility to take advantage of higher cash flow and/or reduce taxation when income is higher. The self-employed owner will often adopt a DB plan in a very strong income year and front-load the contribution stream to more closely match tax deductions with expected income. Varying contributions based on your business’ income can be a powerful strategy to minimize taxable income over the duration of the Plan.

Self-Employed Defined Benefit Plans May Reduce Payroll Taxes

Defined Benefit Plans are not limited by the 25% compensation limit that SEP-IRA and 401(k) plans have. This feature allows an owner to reasonably pay themselves a lower W2 wage and save more for retirement.  A lower salary equals lower payroll taxes. Defined Benefit Plans not only provide substantially higher income tax savings than other retirement vehicles but may also result in lower payroll taxes.

Defined Benefit Plans Provide Creditor Protection

Generally speaking, Defined Benefit Plans are protected from creditors in the event of bankruptcy. The ability for you to shift business assets, which are subject to seizure, to a protected Defined Benefit asset can be a big advantage and add another layer of protection.

Add a Solo 401(k) Plan for Additional Tax Savings

For someone who is self-employed, Defined Benefit Plans allow for substantial contributions. But what many people don’t know is that they can pair a Defined Benefit Plan with a 401(k) plan to allow for even more savings. By adding a 401(k) Profiting Sharing Plan, an additional $43,100 per year may be possible.

Self-Employed Spouses Further Increase Tax Deductions

If the business owner’s spouse is an employee, savings could be greatly increased. While you do need to factor in your spouse’s salary and role in the business, adding a spouse to your plan can provide the potential to double both contributions and tax savings.

Under what circumstances might a defined benefit not be the right choice?

  • You will also require recordkeeping and TPA (Third Party Administrator) services to manage your plan’s contributions and keep you in line with IRA guidelines, in fact, a defined benefit plan is the most expensive type of plan to maintain you will need to plan for these costs each year.

  • If you have employees it’s important to know that the cost for administration will likely go up and you will be required to contribute on their behalf.

  • While DB plans do offer some flexibility, if you fall under or over the allowable amount you will be charged an excise tax.  You must be prepared to continue to make contributions for each year you plan to keep the plan open. 

Anything else you need to consider?

  • You will likely need a Financial Planner knowledgeable with Employer-Sponsored Retirement Plans to help you set up your Defined Benefit Plan and understand all of your options and make sure to engage a knowledgeable CPA.  

  • In order to receive a 2020 tax deduction within a Defined Benefit Plan, you must adopt the plan by 9/15/2021 (business tax filing deadlines with the IRS). 

Still have Questions?

Reach out to one of the Advisors at LA Wealth Management to ask about your specific situation. 

Laurie Allen, CFP

(310) 984-0082

Laurie@lawealthmanagement.com

www.LAWealthManagement.com

Sources:

https://www.irs.gov/retirement-plans/defined-benefit-plan

https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-defined-benefit-plan

Securities and Investment Advisory services offered through GWN SECURITIES, Inc. A Registered Investment Advisor .11440 N Jog Road, Palm Beach Gardens, FL 33418 561-472-2700, Member FINRA, SIPC LA Wealth Management and GWN SECURITIES, Inc. are not affiliated

Information provided should not be considered as tax advice from GWN Securities, Inc. or it’s representatives.  Please consult with your tax professional.

Laurie Allen