Massive Tax-Deductible $200k Retirement Plan Contribution for Self-Employed

What if you could make a $200,000 tax-deductible retirement plan contribution?

For maximizing taxable deductible retirement contributions Defined Benefit (DB)plans can blow away Profit Sharing, Keogh, SEP or stand alone 401k’s. For self-employed people that earn $280k+ and want to max their contributions DB’s are the way to go.

For many self-employed people that are happy putting away $56,000 or less per year Solo 401k’s are potentially the way to go.

Imagine this scenario:

52 year-old business consultant has an S Corp and wants to maximize his/her retirement plan contribution and minimize current taxes:

He/She can set up a defined benefit pension plan and couple it with a 401k allowing for a contribution of roughly $238,000 per year!

Here’s how that breaks down:

Defined Benefit Only:
2019 Business Contribution:      $197,000 – Business expense
Tax Savings @ 37%:                    $72,800

Defined Benefit+ 401(k):
2019 Business Contribution:      $238,800
Tax Savings @ 37%:                    $88,300

Projected Defined Benefit Only Accumulation: $2.73 Million in 10 years

What is a defined benefit plan? 

It’s industry jargon for a pension. We’ve all heard of a pension plan, though they are less common these days. 

Who should consider this:

Eligibility Checklist

Here’s a quick test to find out if is right for you.:

• 40+ years of age

• Typically earns at least $100,000 annually in one of these ways:

  • Sole practitioner or owns business with family

  • Self-employed as primary means of earning a living

  • Second occupation in which client works for himself or herself

  • Independent Contractor rather than an employee

• Wants to contribute more than $56,000 annually to their retirement or a higher percent of income than allowed in a 401(k) or SEP

• Expect to be able to make that contribution for at least three years

High Income, Self-Employed (Sole Business Owner’s) people that want to sock away the maximum possible for retirement, read on.

First, let me say to not be mad at your accountant for not telling you about this. Most tax preparers gather your tax related information and tell you want you owe Uncle Sam. The strategy or advice is often somewhat limited.

You are considered a “business owner” and eligible for these plans if you have earned income that is reported as Net Profit on your Schedule C and is subject to self-employment tax. This is income from work you are doing even if this is part time, secondary income. And, if you own a corporation, your W-2 income is considered compensation for small business retirement plans.

Options for scenario above:

Can’t beat a traditional defined benefit plan designed to meet the tax savings and retirement income needs of individuals with high self-employment income and owner-only or family businesses. These plans provide large tax-deductible contributions averaging $100,000+ annually. AS you can see, adding a 401(k) plan can increase the contribution and add flexibility.

Key Advantages of Defined Benefit Plan

• Allows the highest contributions to a qualified plan – $100,000 or more and as much as 100% of compensation, depending on a number of factors

• Contributions are fully tax deductible – saving huge amounts in taxes

• Investments grow tax-deferred building wealth faster than a taxable investment

• Clients and their advisors may invest plan contributions in marketable securities, such as stocks, bonds, ETFs, mutual funds and annuities, they choose

• Reduces adjusted gross income making itemized deductions and personal exemptions worth even more

• Tax-free roll over to an IRA at retirement (or at plan termination)

Why are the allowable contributions allowed so high?

Most people are familiar with “defined contribution” retirement plans which include 401k, SEP IRA, Keogh, Profit Sharing, etc. With these plans the law defines the amount of the allowable contribution.

The defined benefit plans works the opposite way. The plan annual income is defined by the plan and then a complicated calculation is made to determine the required contribution each year.

In the example above it was assumed the consultant would retire in ten years at age 62. Based on the planned annual retirement income (pension) beginning age 62, the lump sum needed was $2.73 million to fund the pension. In order to grow the pension balance to $2.73 million in only ten years, an annual contribution of  roughly $197,700 will be needed. HOORAY, IF YOU HAVE THAT MONEY TO SHELTER FROM YOUR BUSINESS INCOME.

Without getting more into the weeds, the older self-employed person has fewer years to contribute and grow their balance, therefore, they have a higher contribution. For 2020, the maximum income that is used in the calculation is $280,000 so any additional income will not impact the defined benefit plan contribution.

Dedicated-DB Defined Benefit Services has a terrific OnePerson plan. Disclosure – I have used their services for my clients.

You’ll need to work with a Third Party Administrator (TPA) to set up and administer a defined benefit plan. There are fees involved for their work, but they are typically only a fraction of what you will save in income tax.

You will also want to set up an investment account in the name of your new Defined Benefit Pension Plan and 401k (if you set this up) plan.

Which Retirement Plan is Right for Me?

Individuals with self-employment income and owners of a 1-10 person businesses, have several options including: SEP-IRA, SIMPLE, 401 (k), 401(k), Defined Benefit, and Cash Balance Plans.

Consult an expert for guidance.

Feel free to contact me directly with questions [email protected]

My favorite administrator and provider of much of the information in this post is Dedicated-DB Defined Benefit Services.