- July 18, 2022
- Posted by: Gunveen Bachher
- Category: U.S Taxes and Businesses
We saw in my last video on a Solo 401k for a small business with no employees and how you can contribute higher owing to contributions from both the employer and the employee bucket. On the other hand, in case of a SEP IRA, you are eligible to have one only if you have employees, usually up to 20 in number. The contribution limits are up to $61k in 2022 which is great!
Though there are some business owners who might want to contribute even more towards their retirement, and they can do so by having something known as a Defined Benefit Plan.
Q. What is a Defined Benefit Plan?
A Defined Benefit Plan is an employer sponsored retirement plan in which contributions are made by the employer to reduce current year’s taxes due.
- Similar to a Solo401(k), a Defined Benefit Plan too can be self-directed into real estate investing.
Q. How is it possible to have large contribution limits in a Defined Benefit Plan?
Defined Benefit Plan contribution amounts are based on math calculations to determine what your retirement benefit would be, and then the calculations figure out what you need to contribute today in order to arrive at your goal. It’s kind of reverse engineering!
Which would mean the older you are the higher your contributions are each year.
It’s very powerful for business owners who are in their 50s vs those in their 30s simply because you are trying to arrive at a specified amount at your retirement age.
Q. So who are the ideal contenders for having a Defined benefit plan?
- An ideal profile for a Defined Benefit Plan would be business owners who are 50 years or older.
- And those who have employees who are in their 20s or 30s.
- And if you want to know how much your monthly retirement check might be, there is a defined benefit plan tool as well that you can use.
Best part, you can use the Defined Benefit Plan in conjunction with a Solo401(k). And that’s fantastic!
Here’s an example:
Alan is a CPA with a successful practice that generates annual profits of $250,000. He has a few part time employees who would help him during the busy tax season, but no one worked for him full time. He had been contributing to a Solo401(k) for years, but he felt he could contribute more than what the Solo401(k) allowed. So, in the first year, he was able to set up a Defined Benefit plan and contribute over $100,000. At his combined federal and state tax rate of 45% the contribution saved him $45,000 in taxes that year plus he had another $100k in his retirement account growing on a tax deferred basis.
Now if Alan uses a Solo401(k) in the same year, he contributes $100k to the defined benefit plan, he decided to put away $162k into his retirement accounts for that year.
Benefits that come with all this activity are massive- the money grows tax deferred.
He received an annual; tax savings of $73k (0.45*$162k= $72,900)
Great way to supersize tax savings and also supercharge retirement wealth.
Bottom line:
Business owners are no longer limited to the few thousands of dollars for IRA or Roth IRA contributions. The tax code is filled with benefits where businesses can stash away $50k to $100k and even more in money each year towards retirement.
If you wish to make higher contributions amounts, have flexibility to borrow, have flexibility to take on outside loans, use a self-directed 401k for real estate investing and investing into other alternative assets.
If you wish to make gargantuan savings, consider use of a defined benefit plan in conjunction with the solo 401k to supercharge your retirement investing and take your tax reduction strategy to another level.
At Gavtax, we provide expert tax planning and preparation services for businesses and individuals. We have a team of qualified professionals who can help you save money on your taxes. Contact us today for a free consultation!