With the potential for tax increases looming in the future, tax mitigation activities take on increased importance. At the same time, there's a growing belief that the goal of attaining financial security in retirement is going to fall squarely on the shoulders of the individual, as certain governmental programs may not be able to deliver as promised.
Putting these two considerations together, business owners may find certain types of qualified retirement plans appealing. However, the ability of many such plans to deliver the value successful business owners are looking for-meaningfully lower taxes coupled with solid benefits for themselves-is sorely lacking. For example, it's not uncommon for 401(k) plans to be top-heavy, meaning successful business owners are unable to personally receive any real value.
What are proving more valuable and consequently more appealing to business owners are defined benefit plans. These often enable business owners to make larger contributions, resulting in larger tax deductions. The most appealing type of defined-benefit plan is referred to as a benefit-focused plan.
This type of plan was brought to life by the Pension Protection Act of 2006, which took effect in 2008.
The benefit-focused plan enables key employees, principals and their families to benefit most from the invested money in the plan. Moreover, these principals have the power to designate who participates in the plan at their companies. It allows them to derive the largest corporate tax benefit of any qualified retirement plan.
One of the most important aspects of the new plan is that it can as much as triple corporate tax deductions when compared to a traditional defined-benefit retirement plan, offering the wealthy individual who owns the company larger potential deductions than he or she could find in any other type of retirement setup.
The benefit-focused plan also creates great business planning and estate planning advantages. If the owners die, the benefits can transfer to their spouses and heirs over their lifetimes. And part of the reason for that is the life insurance component in the plan.
In a benefit-focused retirement plan, the owner purchases life insurance as part of the funding mechanism for the plan structure. Not only does he then benefit by getting life insurance using pretax dollars, but the proceeds of the insurance when he dies are income-tax free and can even be estate-tax free. This benefit proves useful in succession and estate planning.
Case Studies
To get a better understanding of the value successful business owners find in the benefit-focused plan, let's consider a few case studies.
Surgeon: A 44-year-old surgeon was unhappy with his 412(e) defined benefit plan because his tax-deductible contributions were declining annually since he started the plan. He was also not satisfied with the low rate of return he was earning on the fixed annuity used to fund his plan.