Defined Benefit Plans
One of the best retirement vehicles can combine a life insurance policy with a retirement account -commonly known as a defined benefit plan (sometimes referred to as a “412i plan” – IRS code). Under this plan, an actuarial calculation of one’s future earnings and required retirement benefits are made. A licensed actuary is needed to determine the minimum and maximum amounts of funding needed each year. In some cases, one’s funding of his/her pension amount can actually exceed the amount of the salary paid (as when one is close to retirement age).
Certain non-discriminatory rules regarding wage amount, age, and tenure must also be strictly followed. Properly structured, the defined benefit plan can save a taxpayer significant tax dollars over the course of many years, despite the expenses of establishing and maintaining such a plan. All amounts contributed into the plan are deductible by the employer (i.e., the company, owned by you).
The amount set aside each year is then deducted as an expense of the employer. In 2021 up to a maximum pension amount of $230,000 (also, $230,000 for 2020) per ‘highly compensated individual’ (you) whose salary maximum is $290,000 ($285,000 for 2020). However, this would be limited to 100% of a participant’s average compensation for the recent highest 3 consecutive calendar years. This expense reduces the business’s taxable income, and thus the overall tax liability of the business entity (which can be a corporation or an LLC). An owner of a business could set aside as much as $230,000 each year for himself alone, into this pension plan (based on those individual maximum salary limits of $290,000 and $285,000 above). Additional pre-funded amounts may also be made into the plan so that during years of higher income, the company may on behalf of the individual, fund even more money into the plan, (and deduct the amounts from company income for that year); to lessen the burden of funding the plan during future possible lean years.
The funding (i.e., payment) of all contributions can be made anytime up until the due date of the subchapter S/corporate (or LLC) tax return (March 15 of the following year) or even through the extended due date (September 15 of the following year).
Again, for the plan to be non-discriminatory, additional employees must be provided with pension plan contributions by the employer and the amounts will again vary, based on the employee’s wage amount, age, and length of employment. Due to the nature of a defined benefit plan, large sums can be accumulated over a relatively short period of time. Upon retirement, amounts are withdrawn each year and the tax is paid on the amount withdrawn based on the life expectancy of the taxpayer (you), generally at a much lower post-retirement income tax bracket.