Learn if a Defined Benefits Plan is Right for You | Blog

Business owners who want to take advantage of the new 20 percent qualified business income (QBI) deduction under the 2017 tax law may want to consider having not only defined contribution retirement plans, such as 401(k) plans, but also defined benefit plans similar to old-fashioned pensions.

Palma Financial Services, Inc. has put together hundreds of these plans for clients over the past two decades. With the experience to make this successful for you and your business, we are here to help you work through the details with the least amount of friction for your business and time.

*As seen on CNBC: Tax changes give defined benefit plans new life*

Defined benefit plans may be especially interesting now to certain entrepreneurs, investors and professional practitioners with earnings too high to take advantage of the QBI ~ Timothy Speiss, partner in charge of EisnerAmper Personal Wealth Advisors

“It’s very significant, and the 2017 tax legislation is important,” Speiss says.

The Tax Cuts and Jobs Act passed by Congress and signed into law by President Donald Trump in 2017 didn’t directly address defined benefit retirement plans, which pay pension benefits based on an employee’s years of employment and final salary. However, it did change tax deductions in ways advisors say make defined benefit plans more appealing.

One important 2017 tax change created the QBI deduction. This lets the owner of a partnership, sole proprietor, trust or S corp deduct from his or her taxable income the lesser of 20 percent of the business’ QBI or 50 percent of W-2 wages the business paid the owner. At the top tax rate of 37 percent, higher deductions can result in hefty savings.

The catch is that business owners in a number of fields including health, law, sports and performing arts cannot use QBI if their adjusted gross income is too high. For married couples filing jointly, the cap is $315,000. It’s $207,500 for heads of households and $157,500 for single filers. This incentivizes business-owning taxpayers to make adjusted gross income fall under the QBI cap.

Speiss said business owners whose income is too high to let them use the QBI may be candidates for defined benefit plans in combination with defined contribution plans, such as a 401(k). If deducting the maximum allowable contributions to a 401(k) still leaves them over the $315,000 cap, they may be able to add a defined benefit plan and use deductible contributions to that to bring their incomes below the cap and save thousands in taxes, according to Speiss.

Coping with SALT limits

Defined benefit plans also help high earners cope with new limits on state and local taxes, or SALT, said Rob Wolfe, certified financial planner and managing director of United Capital. The 2017 tax law limits SALT deductions, including property taxes and state income taxes, to $10,000, noted Wolfe, whose clients include high-earning athletes.

The SALT limit means a professional basketball player earning $10 million in W-2 wages in a state like California, where the state income-tax rate is 10 percent, could deduct just $10,000 on his federal return instead of the $1 million in state income tax deductible under the old law, Wolfe said. A defined benefit plan can’t directly reduce W-2 taxes. But if the player also endorsed athletic gear for pay, he or she can set up a company to receive endorsement fees and fund a defined benefit plan to trim the total tax bill.

This is an example of how defined benefit plans can fit into today’s tax environment, Wolfe said. “The defined benefit plans themselves haven’t changed substantively based on the new tax law,” he added. “It’s just that the new tax law will drive some people to find more tax deductions this year.”

Defined Benefit Plan Limits

Defined benefit plans aren’t suitable or even available for every high-income earner. For instance, sole proprietors who didn’t set up a defined benefit plan by April 15, 2018, can’t deduct contributions from 2017 income. Other business entities also have dates by which they must have defined benefit plans in place to use them for 2018.

An important consideration is that under federal law, employers can’t use defined benefit plans strictly for their own benefit. “The caveat to be aware of is if you have employees, you have to make sure you’re benefiting them as well,” said Speiss at EisnerAmper Personal Wealth Advisors.

That means defined benefit plans may be less suitable for business owners who don’t have reliable, steady income to fund employee contributions, said Jason Labrum, certified financial planner and president of Labrum Wealth Management. “The cost can be higher with a defined benefit and given the discrimination rules, it often becomes cost prohibitive because you are required to put money in for employees,” he said.

Lower-cost, more flexible defined contribution plans using vehicles such as Roth 401(k) plans may be preferable for many business owners, Labrum added. “We typically see defined benefit plans working best for the self-employed or businesses with few and typically younger employees,” he said.

A Defined-Benefit Renaissance

Defined Benefits Plan Renaissance

The popularity of defined benefit plans has been slumping for decades, but thanks to the new tax law, that could be slowing or even reversing. “Although we installed a significant number of new defined benefit plans for clients in years past, including 2017, we expect the adoption rate in tax years 2018 and beyond to increase at an accelerated rate,” said Wolfe at United Capital. “It just makes sense for clients with the right fact pattern.”

Not everyone is so enthusiastic. Defined benefit plans have a one-time allure right now because the new tax law lets companies with a fiscal year ending by Septermber 15, 2018, take pension deductions at higher 2017 tax rates, according to Joseph Roseman, managing partner with O’Dell, Winkfield, Roseman and Shipp.

But, longer term, Roseman thinks companies will continue to steer clear of defined benefit plans in favor of defined contribution plans that cost less and shift risks off employers and onto employees. “I don’t see that trend changing because of the new tax law,” he said.

Speiss at EisnerAmper Personal Wealth Advisors still maintains that defined benefit plans will appear in more discussions with business owners and advisors.

“We do think that defined benefit plans are going to be reexamined,” he said. “And we do think that employers are going to be adopting them more.”

Contact us so that we can discuss how this plan can benefit you today.

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