A qualified defined benefit plan, sometimes referred to as a Pension Plan, is a commonly overlooked tax benefit for businesses and/or business owners. Eligible businesses for this plan are:
- Sole proprietors
- C-Corporations
- S-Corporations
- Partnerships
- Limited Liability Companies
- and Family Limited Partnerships.
This plan is primarily used for pass through entities, so we rarely see them utilized by C-Corps. We most commonly see this type of plan used for smaller businesses however, this does not exclude larger businesses by any means.
These types of plans allow the largest tax-deductible contribution to a qualified retirement plan. In many cases this gives a business and/or individual a 6-figure tax deduction. We have even seen cases in which it offers 7 figures in deductions.
With this type of plan, generally, the older the individual, the larger the contribution they can make. This is because the benefit is defined, not the contribution. Meaning, the older the individual, the more they can contribute to “catch up” to the maximum defined benefit.
The Tax Cuts and Jobs Act (TCJA) also allows this to be paired with IRC section 199A. This portion of the tax code allows eligible taxpayers a deduction of up to 20 percent of qualified business income (QBI) when operating under certain eligible business entities and within certain industries.
To summarize some of the key advantages:
- A qualified defined benefit plan can provide substantial retirement benefits without market risk
- From a retirement standpoint, it gives the largest tax deduction under the law
- Can provide guaranteed income you cannot outlive
- Reduces, diversifies, or eliminates market risk
- Allows you to buy estate planning tools on a pre-tax basis
- There is no full-funding limitation under IRC Section 404(a)(1)(A)
- No quarterly contributions are required; and
- There can be no under-funding because contributions are based on the guaranteed provisions of the level premium contracts
While all the above sounds great, there are some disadvantages to this plan:
- It requires contributions that must be made each year
- No policy loans are available
- There is limited flexibility in contribution allocations
- The type of investment allocations within the plan may be limited
There is still time to get this in place for a 2021 deduction.
Dan Nuwash, MBA is the Founder and Managing Partner of Finance for Thought and can be reached through our website.
Schedule an introductory Zoom meeting or call with one of our partners.
Sources:
https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-a-comparison-for-businesses
https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-defined-benefit-plan
https://www.irs.gov/retirement-plans/defined-benefit-plan
https://www.planadviser.com/412e3-plans-for-small-business-clients/
https://www.irs.gov/businesses/small-businesses-self-employed/deducting-business-expenses