Personal Defined Benefit Plan: Self-Employed Strategies [+ IRS Pitfalls]


What if you could boost your self-employed retirement contributions by an extra $100,000 annually? A personal defined benefit plan can do this for you.

While these plans allow large contributions, they can be complicated to understand. But we’ll show you why these plans are one of the best retirement options.

In this article, we will discuss how these plans work and point out a few tips and tricks. The goal is to give you some insight into how to set up a plan. Let’s jump in!

Background

Business owners that make more than $250,000 per year are ideal candidates. Plan contributions reduce your taxable income, which means substantial tax savings.

One thing to watch out for, however, is the fees. For most business owners, the benefits outweigh the fees, but they’re worth understanding:

  • $1,000 – $2,000 to set it up
  • $2,000 – $3,000 in annual fees
  • 0.25 – 1% off the plan’s value in investment management fees

Employees have options at retirement. You can either choose to take it all at once, in one lump sum and roll it into an IRA or take an annuity.

What is a personal defined benefit plan?

Do you own a business? Are you worried about retirement savings? What if there was a way to save more than $1 million in just a short time? It’s possible with the personal defined benefit plan.

Many advantages still render defined benefit plans likable by employees including guaranteed benefits, employer contributions and responsibilities and risks vested on the employer. It is, therefore, an important tool for employers for recruiting and retaining key employees.

chart with finance, tax and debt, Self-Employed

However, employers have to ensure that they can sustain a defined benefit plan. They have to ensure that they have a constant cash flow which can maintain high contributions towards their plans over the period. They also have to meet high administrative costs and consulting fees associated with the self-employed plans.

Can a self-employed person have a defined benefit plan?

Under a defined benefit plan a participant’s account earns a pay credit, normally 5% to 8% of the employee’s salary each year, plus an interest credit, at a fixed rate or variable rate on the account balance.

When the plan reaches its time to distribute the funds, one can move their funds to another tax-advantaged account in order to defer tax until when they require the distribution.

Get a FREE IllustratioN!

Just give us a little information and we’ll get you a custom illustration in 24 hours.

To qualify for a self-employed (or “solo”) defined benefit plan, one has to have a substantial recurring surplus income from the business they own. The following criteria should also be met:

  • Owner of a disregarded LLC that employs only the owner and spouse;
  • Partner in a partnership that employs just the partners or partners and spouses;
  • Sole owner of a corporation (or an LLC taxed as a corporation) that employs only the owner and spouse;
  • Owner of the company who meets the above requirements and employs part-time employees, but all of them have not met the 1,000 hours requirement in a year starting from the date of employment.

An actuary makes an assumption of contributions towards a personal defined benefit plan by reviewing investment returns on an annual basis. Specific assumptions and calculations used by an actuary ensure proper contribution levels that will ensure a defined benefit plan grows at a predetermined rate that secures a participant’s retirement period.

Personal pension plan set up

  1. Put together a plan document outlining all the plan details, the contributions to be made and the interest rates.
  2. Open a personal defined benefit plan investment account. It is critical to follow the plan rules for set-up.
  3. Determine the amount of plan funding considering the age, compensation, plan document, actuarial assumption, and IRS regulations. Your plan actuary will assist you with this.
  4. After receiving the actuary contribution range, you can deposit funds to the plan account. Please note that your contributions must be made by your business’ tax –filing deadline, including extensions. The deadline is April 15, for unincorporated businesses including extensions, and March 15, including extensions for corporations and LLCs, organized as corporations. As such, the self-employed have many options.
  5. Look for a third-party administrator (TPA). Managing all plan activities may be a difficult task for you, contact a third-party administrator to handle much of the hefty administrative work so you can concentrate on the remaining investment work.

Contribution limits

Just like any other retirement plan, defined benefit plans also have limits on the amount that can be contributed annually.

Limits are set with regards to age, as a participant nears his retirement age, contribution limits are higher. This is because older persons have fewer years to save, they, therefore, have to squeeze like twenty years into ten years of saving. Plan document, subject to IRS, specifies the contribution limit of a business owner.

You may be able to weight your contributions based on age. In other words, you may give slightly larger contributions to older loyal employees and a slightly smaller contribution to younger employees.

Book a FREE 30 Minute Call!

Schedule a FREE call and we’ll show you how we structure plans for maximum tax efficiency.

How to know if a personal defined benefit plan will work for you

Here are the five steps in determining the correct plan structure.

  1. You are looking for large retirement contributions

    Plans make sense for small business owners that are looking to contribute more than $50,000 per owner. You can terminate a plan as long as your intent is to have a permanent plan. But situations can change that required plan closure. But if you are looking for large contributions, these plans are your best option.

  2. You have consistent income

    Companies should have large and reliable income and be able to contribute at least the minimum contribution amounts. This is often the case for professional services businesses, including physicians and attorneys. But any owner looking to make the large contributions are good candidates.

  3. You don’t think you will have any problems making contributions

    Companies that can consistently make employee contributions year over year, along with a relatively decent interest rate. A business owner must make annual contributions. However, they can always freeze or terminate the plan (depending on business conditions and financial situation).

  4. You need to “catch-up” on retirement

    Self-employed business owners who are behind on retirement and want to “turbo-charge” their contributions retirement. The personal defined benefit plan contribution is held in one large, pooled account. Upon retirement, each employee has can take their account balance either as a lump sum payment or as annuity payments.

  5. You want to combined plans

    Business owners can combine a 401(k) and a personal defined benefit plan simultaneously. This will enable larger overall contributions but allow the flexibility to not make the 401(k) contribution (if desired). As an owner, there are several strategies you can use to maximize your retirement savings.

ProsCons
Annual contributions of $100k+Conservative investment profile
Custom plan designMandatory contributions
Tax-deductible contributionsPermanent plan structure
Flexible funding rangesHigh administration costs

What about a defined benefit plan for self-employed with an LLC?

Self-employed defined benefit plans are qualified plans. Therefore, business owners are assured of a tax deduction and high contribution levels. They are also protected from any bankruptcy lawsuit and can be rolled over to other IRAs or pension plans. Business owners should, therefore, take advantage of defined contribution plans coupled with other plans like 401(k) plans.

Bottom line

It’s important to know and follow all IRS rules regarding the cash balance plan. It can be a great way to grow your own nest egg as an owner, while contributing to your employees’ retirement.

Using the tips above and including only loyal and ‘of age’ employees is the easiest way to have your own retirement plan from your company’s earnings, while helping those that work hard for you on a daily basis.

You have worked hard to build your business and now you want to build your retirement savings. A personal defined benefit plan may be the perfect option.

Paul Sundin

Get a FREE 30 Minute Consultation

Reach out to us today and we'll show you our favorite strategies! We can show you how to structure a plan for maximum tax benefit and provide you with a custom plan design.

Leave a Comment