The defined-benefit plan is a vehicle provided by the IRS for the purpose of furnishing employees with retirement benefits and offering a tax advantage to employers. Because defined-benefit plans are designed to supply pre-established retirement benefits, many tax advisors compare them to the old-school type of pension plan that businesses no longer use. Based on actuarial calculations and a preselected formula, the employer contributes funds to the plan in order to provide a guaranteed retirement benefit to the employee. Contribution limits for defined-benefit plans are generally higher than for other types of retirement accounts so they offer a greater tax advantage to those who fund them, while, at the same time, providing a fixed retirement income to plan participants.
Although traditional IRA and 401(k) plans are adequate retirement saving options for most taxpayers, the maximum contribution limits of $6,000 for IRAs and $18,000 for 401Ks provide little shelter for those with higher incomes. However, in addition to these well-known plans, the IRS tax code provides additional tax saving strategies for high income taxpayers and those seeking to shelter gains received from taxable transactions. One such option is the defined-benefit plan. Each year actuarial calculations are used to determine a taxpayer’s future annual benefit need, after which the business is allowed to make tax deductible contributions to fund this need. The only stipulation is that contributions may not exceed the maximum amount set by IRS guidelines which is $210,000 for 2016. These contribution amounts not only allow a full tax deduction for the amount contributed to the plan but have the added benefit of being held in a tax deferred plan that may continue to accumulate over time. Defined-benefit plans, like other plans, are taxed only when the distributions are made upon retirement.
The defined-benefit plan provides significant tax benefits to both ongoing high income taxpayers and taxpayers entering into significant taxable transactions. Because the contribution limits are determined primarily by income and age, they can serve as an effective tax planning tool for these types of taxpayers. For example, it is not uncommon for a business owner who is considering selling a business to be older in age and to have most of their wealth accumulated in the business itself rather than retirement accounts. The annual contribution amounts allowed by the define-benefit plan are far in excess of the 2016 total employer/employee contribution limit of $53,000 allowed for most qualified retirement options and essentially provide a means for such an individual to quickly fund a retirement account that may have taken a full career of contributions for a typical W-2 employee.
In addition to creating retirement accounts, there are many advanced uses of defined-benefit plans to be considered in combination with other tax planning tools. One of the most common of these is the use of the defined-benefit plan to offset the gains associated with an installment sale. Consider, for simplicity, a taxpayer selling a business for $1,000,000. A straight taxable sale, even at long term capital gains rates, could result in combined federal and state income taxes of 35% or more. However, installment sale rules allow the sale income to be reported over a period of three years during which time the individual can make annual defined-benefit contributions of $150,000 each. If the transaction is structured in this way, the income from the installment sale receives preferential long term capital gains treatment while the defined-benefit plan allows 45% of the that income to be shielded from current tax.
The experienced professionals at CGT Solutions are aware of the many tools available to both reduce and defer tax on all high income and transactional tax situations. If you are interested in investigating the tax advantages provided by the defined-benefit plan, call us today at 888-888-8888 or fill out the online request form to receive a free, no obligation consultation.