Mike DiNuzzo, CFP®, ChFC®, MSFP, is Senior Vice President, Partner, and Risk Management Team Leader at DiNuzzo Middle-Market Family Office™ located in Pittsburgh, PA. 

When dealing with all the day-to-day challenges of growing a business, tax mitigation and long-term wealth management planning often get set to the side. You’re busy running your business. It’s understandable. Fortunately, with the right tools and professionals in place, it doesn’t take a lot of time or effort to set yourself up for substantial improvement and savings in both the short and long term.

Russ Alan Prince: What is a sophisticated defined benefit retirement plan?

Mike DiNuzzo: A sophisticated defined benefit retirement plan is a way for a business owner to put away the most money possible into a qualified retirement account, maximizing your tax deduction, significantly growing retirement accounts, and even providing life insurance death benefits at the lowest possible cost.

These plans are not new, but they aren’t commonly implemented. And when they are, they are often mismanaged because they are highly specialized. Very few professionals completely understand how they work. But, when done right, entrepreneurs can put much more money pre-tax into their plan than even the most aggressive alternatives.

In a sophisticated defined benefit retirement plan, the investor gains significant income tax deductions from their contributions. Additionally, the money in the account grows tax-deferred. And the entrepreneur’s family benefits from a life insurance death benefit at favorable terms than what’s often available outside of these plans.

Prince: What mistakes do people make regarding sophisticated defined-benefit retirement plans?

DiNuzzo: While these plans have the potential to give you a better return, significantly lower your tax obligations, and even improve your risk management plan with the life insurance component, they need to be monitored much more closely than other plans, which many people don’t do.

Additionally, the plan must change when circumstances change in an individual’s business. Say, for example, a relatively small business of thirty-five employees suddenly acquires another business of over 200 employees. This will change the plan.

Moreover, these plans operate using an actuarial calculation. Thus, different rules apply for contributions and must be recalculated regularly. For example, a business owner who invests heavily into a sophisticated defined benefit retirement plan that performs very well in the first year might have their contribution level in the second year adjusted from what they initially expected.

Finally, sometimes entrepreneurs and even some unsophisticated so-called professionals try to force a sophisticated defined benefit retirement plan into a situation where they simply don’t work because they find these plans so attractive. Or, they bend the rules to try to benefit from tax benefits to which they are not entitled. Those strategies won’t hold up, and often create legal liabilities of their own.

Prince: Who are the best candidates for sophisticated defined-benefit retirement plans?

DiNuzzo: A business owner with thirty-five or fewer employees can benefit from these plans the most. In addition, they need a high enough free cash flow that they can direct a significant portion of the plan. So, if the business owner requires all free cash flow for their personal or business expenses, this plan may not work. 

Additionally, the actuary calculates the distinction between the owners and non-owners in their entity’s structure. An example of an ideal candidate for this could be a social influencer with two or three employees. In this case, they have high cash flow and seek tax mitigation, and there is a distinction between them and their employees.

Prince: How do you advise your clientele on a decision about sophisticated defined benefit retirement plans?

DiNuzzo: It’s something we look at DiNuzzo Middle-Market Family Office during our detailed discovery process to identify ways to add value to successful closely held business owners and affluent families. Two of the primary ways we add value are through tax mitigation and risk management and, when these plans are a fit, they help us craft customized solutions to reduce taxes, manage risk, increase returns, and more.

When we do believe these plans might be a fit for them, I help them understand that these plans are usually a combination, typically of investments and life insurance. These plans work best if one’s business is doing well and is projected to do well over the next three to five years, because of the cash flow requirement.

I also advise them to make sure they are working with an experienced and integrated team that understands all aspects of these plans to make sure the plan is put in place correctly. I then walk them through all their options, the numbers, and how the plan should work for them. Together, this allows my clients to do what they do best—review options and make informed decisions about what is best for them, their family, and their business.

RUSS ALAN PRINCE is the Executive Director of Private Wealth magazine (pw-mag.com) and Chief Content Officer for High-Net-Worth Genius (hnwgenius.com). He consults with family offices, the wealthy, fast-tracking entrepreneurs, and select professionals.