[GUEST COLUMN] William H. Black, Jr.
Running a successful business is fantastic. However, with success comes other issues like how to manage taxes. Many are aware of “qualified plans” or programs like 401(k) and
Defined Benefit plans, which allow the sponsoring employer
(you) to current income tax deductions for Plan contributions, tax
deferred growth on Plan assets, asset protection under ERISA, and
the ability to roll your account, income tax free, to your IRA.
There are, I’ve found, many misconceptions about “qualified
plans.” Known as “qualified” because contributions qualify for a
current income tax deduction, these plans may be your best tax
planning tool. Qualified plans come in two general styles, Defined
Contribution (DC) and Defined Benefit (DB). Defined Contribution
plans are your 401(k)’s, SEP’s, etc. You define the contribution that
is made to the plan. This year the maximum contribution is 25
percent of payroll, not to exceed $52,000 for any one participant.
What’s unknown is what you will receive in the future. It depends
on how much is put in each year, how many years you contribute,
and what it earns on investments. Whatever that works out to,
that is what is available in the future.
The traditional plan is the Defined Benefit plan. Think back to
our parent’s generation (or grandparent’s). They went to work for
a company for 30 years and retired on 75 percent of their salary.
That company’s Plan defined the benefit that was paid at retirement. At one time Defined Benefit Plans were the cornerstone of
one’s retirement. Lately, they have fallen out of favor after taking
on negative connotations due to the financial crisis. Why the negativity? Because of articles in the press about the “underfunded”
or “unfunded” liabilities in DB plan. However, these articles about
problem plans are almost always about DB plans sponsored by a
state or county government or large company listed on the exchange. Most of the larger companies have stopped their DB plan
and replaced it with a DC plan. That’s nothing new.
However, the DB plan remains a fantastic program for the
closely-held business and professional practice. How can that be?
Because the small business is run by focused and driven individuals. The DB plans set up for this sector are not about employee
benefits or “retirement” as much as they are about the income tax
deduction, the tax deferred growth, the asset protection under
ERISA (the Employee Retirement Income Security Act of 1974), and
the fact they are approved, in writing, by Internal Revenue (
Favorable Determination Letter). For these entrepreneurs, DB plans can
be an ideal vehicle, allowing you to keep a larger share of your
hard earned dollars!
However, many businesses and professional practices have not
implemented any type of qualified plan. How can this be? With
all the benefits listed above, why have more not taken advantage?
In one word, misconceptions: “A Plan will cost too much to
administer.” “My employee costs will kill me.” “I’m already paying
salary, sick pay, vacation pay, matching Social Security, and Medi-
care, paying into Workman’s Comp, unemployment … I don’t
want to add more overhead.”
All of that is nonsense. A custom designed DB plan can provide
substantial tax benefits to the business or professional practice
owner without any of the above. For those generating more than
$200,000 a year in taxable income, consider setting up a pension
plan — even if you already have existing “retirement” invest-
ments, such as a 401(k) or IRA. In fact, many clients that come to
us already have an existing plan. Their plan is OK, it’s just that the
deductible contribution is not enough. They need a larger annual
tax deduction. This situation is when the DB plan makes sense.
Is this your situation? Then, the following are a few of the key
benefits that DB plans have to offer:
• Higher annual contribution limits — Like a 401(k) plan or an
IRA, DB plan contributions are income tax deductible on the busi-
ness’s or professional practice’s tax return. A key difference is the
higher tax-deductible contribution limits allowed in DB plans. A
DB plan can create substantial annual tax deductible contributions
over and above existing 401(k) plans. The maximum deductible
contribution is around $200,000. Keep in mind that is the maxi-
mum; one can do anything less than that. The point? I’ve never
had a client ask for a DB plan to be designed to provide a specific
benefit. The answer is we all have a budget. It is that budget that
drives the DB plan’s contribution. In other words, a client will say
“I’d like an additional deduction over and above my 401(k) plan of
$X dollars.” We design the plan that absorbs that annual contribu-
• Asset Protection — Under ERISA, pension benefits are “
inalienable and non-assignable.” In other words, you cannot be
alienated from your pension monies. This has been tried all the
way to the Supreme Court in Patterson v. Schumate, but it is not
even up for discussion. Think about it this way: How did O.J. run
around leading a decent lifestyle when Ron Goldman’s father had
a judgment against him? O.J.’s NFL pension was a protected asset!
For anyone with ”Doctor” in front of their name, for anyone with
a successful and profitable business, it’s not IF you will be sued but
WHEN. In today’s litigious society, frivolous lawsuits are commonplace. Pension monies are one asset these judgment creditors
cannot take away.
The Tax Planning Tool for Success