What if you could boost your retirement contributions by an extra $100,000 annually?
A personal defined benefit plan can do this for you. This is why it is one of the best retirement options (even considering 401k plans).
However, a defined benefit plan for the self-employed can be complicated to understand. So I will try to simplify it in this post.2021 Easy Navigation
- Self-employed retirement planning
- Can a self employed person have a defined benefit plan?
- Personal plan
- Contribution limits
- What about a defined benefit plan for an LLC?
Self-employed pension planning
Many advantages still render defined benefit plans likable by employees including guaranteed benefits, employer contributions and responsibilities and risks vested on the employer. It is, therefore, an important tool for employers for recruiting and retaining key employees.
However, employers have to ensure that they can sustain a defined benefit plan. They have to ensure that they have a constant cash flow which can maintain high contributions towards their plans over the period. They also have to meet high administrative costs and consulting fees associated with the plans.
Can a self employed person have a defined benefit plan?
Under a defined benefit plan a participant’s account earns a pay credit, normally 5% to 8% of the employee’s salary each year, plus an interest credit, at a fixed rate or variable rate on the account balance.
When the plan reaches its time to distribute the funds, one can move their funds to another tax-advantaged account in order to defer tax until when they require the distribution.
To qualify for a self-employed (or “solo”) defined benefit plan, one has to have a substantial recurring surplus income from the business they own. The following criteria should also be met:
- Owner of a disregarded LLC that employs only the owner and spouse;
- Partner in a partnership that employs just the partners or partners and spouses;
- Sole owner of a corporation (or an LLC taxed as a corporation) that employs only the owner and spouse;
- Owner of the company who meets the above requirements and employs part-time employees, but all of them have not met the 1,000 hours requirement in a year starting from the date of employment.
An actuary makes an assumption of contributions towards a personal defined benefit plan by reviewing investment returns on an annual basis. Specific assumptions and calculations used by an actuary ensure proper contribution levels that will ensure a defined benefit plan grows at a predetermined rate that secures a participant’s retirement period.
A business owner has to ensure that he makes contributions annually until the termination of the plan or until it is frozen. A plan can be terminated within its first ten years of inception or can stay for a longer period depending on the financial ability of an owner’s business.
Personal pension plan set up
- Put together a plan document outlining all the plan details, the contributions to be made and the interest rates.
- Open a self-employed defined benefit plan account. It is critical to follow the defined benefit plan rules for set-up. If the plan accommodates the spouse or partners and their spouses, one account will be used to pool the contributions.
- Determine the amount of plan funding considering the age, compensation, plan document, actuarial assumption, and IRS regulations. Your plan actuary will assist you with this.
- After determining the contributions and have been approved by the plan actuary, you can deposit fund to the self-employed defined benefit plan account. Please note that your contributions must be made by your business’ tax –filing deadline, including extensions. The deadline is April 15, for unincorporated businesses including extensions, and March 15, including extensions for corporations and LLCs, organized as corporations.
- Look for a third-party administrator (TPA). This is an organization specialized in offering services on pension plans. Managing all plan activities may be a difficult task for you, contact a third-party administrator to handle much of the hefty administrative work so you can concentrate on the remaining investment work.
Just like any other retirement plan, defined benefit plans also have limits on the amount that can be contributed annually.
Limits are set with regards to age, as a participant nears his retirement age, contribution limits are higher. This is because older persons have fewer years to save, they, therefore, have to squeeze like twenty years into ten years of saving. Plan document, subject to IRS, specifies the contribution limit of a business owner.
How to know if a pension plan will work for you
- You are looking for large retirement contributions. Small business owners that are looking to contribute more than $50,000 for each owner.
- You have consistent income. Companies that have a large reliable source of income streams and are able to contribute at least the minimum contribution limits.
- You don’t think you will have any problems making contributions. Companies that can consistently make employee contributions year over year, along with a relatively decent interest rate.
- You need to “catch-up” on retirement. Small business owners who are behind on retirement and want to “turbo-charge” their contributions retirement.
- You want to combined plans. Business owners who desire to combine a 401(k) and a personal defined benefit plan simultaneously.
What about a defined benefit plan for an LLC?
Defined benefit plans are qualified plans. Therefore, business owners are assured of a tax deduction and high contribution levels. They are also protected from any bankruptcy lawsuit and can be rolled over to other IRAs or pension plans. Business owners should, therefore, take advantage of defined contribution plans coupled with other plans like 401(k) plans.