How a Defined Benefit Plan Could Lower Your Tax Bill

By C.J. Neff on February 6, 2023

“401(k)” – it’s practically synonymous with “retirement plan” at this point. But, 401(k) plans are still the relative “new kid on the block” in terms of retirement plan options. They were only introduced about 40 years ago, in 1978.

Pension plans – which many of our parents and grandparents had – have been around significantly longer and nowadays seem like relics, something you think about alongside black and white televisions or actual dials on the radio.

This is a case, however, where an “oldie” can also be a “goodie”.

In specific circumstances, pension plans help high-income business owners save tens of thousands of dollars or more per year in taxes. How’s that possible? Well, let me explain.

Let’s start by using a familiar example. A 401(k) allows an employee to defer up to $22,500 annually in contributions (as of 2023). Or, if you’re 50 or older, the limit is bumped to $30,000. However, if you earn a significant amount in income – say $500k or $1m per year – you may be looking for ways to defer more than $30,000 of income and to reduce your tax bill much more than a 401(k) plan allows.

Pension plans – more formally known as “defined benefit plans” – allow contributions of up to $250,000 per year (or more!) for retirement, nearly 10 times as much as a 401(k), and typically taxes can be deferred on that entire amount. If you have the “privilege” of qualifying for the highest U.S. federal tax bracket of 37%, the tax savings of this technique could equate to more than $90,000 annually.

We work with many highly compensated professionals, and we’ve seen them realize incredible tax savings over and over again using this technique. Additionally, these plans often become the cornerstone of a client’s retirement portfolio. Reduced tax liability and increased retirement security. It’s a win-win.

Another great benefit of these plans is that they’restrongly protected from creditors. Thus, they’re also a form of asset protection.

Now, it’s important to say that a defined benefit pension plan is not for everyone. These plans are complex to set up, and they really work best in specific circumstances.

• First, these plans work best for business owners. These plans are employer-provided, so you need to have the decision-making power to implement this for your business. You can’t do this without a business entity.
• Second, these plans work best for small businesses. Many, if not most, employees will need to participate in the plan. There are ways of skewing benefits towards owners, but it’s important to realize that some benefits will need to be provided to employees as well. Generally, as long as the business is relatively small, 90% or more of contributions can be funneled towards the owners.
• Third, you need to be reliably earning significant income. These plans only make sense when you’re able to save significantly more than $50k annually for retirement. Otherwise, you should just use a 401(k) or similar plan type. If you’re looking to save $100k, $200k, or $250k+ annually for retirement, that’s when this strategy can make a ton of sense.
• Fourth, you understand the ROI of working with professionals. We would need to work with your CPA and a third-party administrator to set this up. There are obviously costs involved, but we would never recommend you do this unless the tax savings far outweigh the costs of implementation.

If you own your business, you’re highly compensated, and you have no employees or only a few employees, it may be worth investigating a defined benefit pension plan. Reach out to us at hello@hightowerlasvegas.com to start a conversation and to determine if a defined benefit plan is right for you.