Are you considering setting up a defined benefit plan but are not sure of the deadline? Well I have some good news for you.
Under the old rules you were required to have the plan set up by the end of the plan year. This is normally December 31st. But thanks to the SECURE Act, things have changed.What you will learn about the defined benefit plan deadline:
- Deadline for establishing a defined benefit plan
- How a defined benefit plan works
- Who should consider a defined benefit plan?
- Add-on 401(k)
- How to set up a defined benefit plan
- Final thoughts
Deadline for establishing a defined benefit plan
The SECURE Act changed the rules and essentially extended the date a plan can be set up. For you to take advantage of a plan, you must establish a plan by the date you file your taxes, including extensions.
For an S corporation that follows a calendar year, meaning you close your books by December 31st, you have until March 15th to set up and fund the plan. A six month extension can be added for you to file by September 15th.
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But remember that the plan also has to be funded by that deadline. So the set up should actually occur well in advance of the deadline. You must fund the plan before filing your tax returns.
How a defined benefit plan works
Why is defined benefit plan such a great retirement strategy? Simply stated, it allows the participant to contribute a substantial amount into retirement and take a significant tax deduction. Let’s look at an basic example below.
Assume a 54 year old physician who earns $500,000 a year. Let’s also assume, that the physician is the only eligible full time employee. Depending on compensation, the doctor could contribute approximately $235,000 into a defined benefit plan.
If the plan is combined with a solo 401k that has a profit sharing component, the doctor can contribute an additional $37,000. This is a total of $262,000. Assuming a tax rate of at least 40% (federal and state), this is a tax savings of $104,000. Not too bad.
Who Should Consider a Defined Benefit Plan?
The ideal candidate for a defined benefit plan is a business owner who is age 40 or older. A plan sponsor with no other employees or only young employees will have the lowest non-owner costs.
The plan sponsor must be aware that the contributions are generally mandatory and feel that future cash flow will support the continuation of the plan. The risks of inflated costs due to market fluctuations and/or the hire of older employees must be anticipated.
Plan sponsors who maintain both a defined benefit and a defined contribution plan have a maximum deduction limit of 6% of eligible payroll. Under EGTRRA, employee contributions towards a 401(k) plan do not count towards this limit.
The result of this change is that employers with defined benefit plans can add on a 401(k) plan that allows for participant deferrals only (no employer contributions).
For the plan sponsor without non-highly compensated employees, this would mean an additional contribution of $19,500 if under age 50 or $26,000 if age 50 or older. If there are common-law employees, the deferral by highly compensated employees would be limited based on the average deferral by those employees.
How to set up a defined benefit plan
- Discuss with an accountant or financial advisor. Meet with your CPA and/or financial advisor a couple months before the end of the year to make sure a plan is right for you.
- Find a plan TPA. The TPA will draft the final plan. But they will also tailor the plan to work best for you and your company.
- Sign the final plan document. In order for the plan to be legal, you will have to sign all plan documents and company resolutions. The documents can take time to review.
- Don’t for get the set-up deadline is December 31st. The deadline of December 31st is the set-up deadline but NOT the funding deadline. Don’t forget these two dates.
- Plan funding. The great news is that you have up until you file your tax return, including extensions, to make your contribution.
Considering a defined benefit plan? You are definitely on the right track. Huge tax savings, high contribution limits and excellent employee benefits are some of the advantages under a defined benefit plan.
Thanks to the SECURE Act you now have until you file a tax return to get a plan set up (including tax extensions). You need to be running defined benefit plan illustrations, multiple scenarios just to find the best plan that will fit well with the company.
Make sure you have communicated your plan intentions to all employees by the end of this month in order to have everyone on board. It is never too early, you better start now!