Author Topic: small biz owners - any self-funded defined benefit plan stories?  (Read 1118 times)

Fuzz

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small biz owners - any self-funded defined benefit plan stories?
« on: December 19, 2019, 06:09:15 PM »
Question for the small biz owners. Does anyone have any stories about setting up a defined benefit plan?

It looks like you can shield tax free any amount of money necessary to generate a defined benefit up to $220K/year.

https://www.irs.gov/publications/p560

So, as a small biz owner, I get 1M in income in a year. I decide to set up a defined benefit plan rather than contribute to my 401K. I go get documents to set up a plan  (where? how?). Then I go to Schwab and spend 1M to buy an annuity that pays out $5600/month for the rest of my life, starting in 20 years. That annuity costs 1M, so I don't pay any taxes on that income for the year.

Does anyone know anyone who has done this? If you were both a high earning business owner and a mustachian, wouldn't this make the most sense? Once you get the defined benefit plan paid for, then you're done.

BTW, I think annuities are kinda underrated around here. This calculator is pretty interesting. https://www.schwab.com/public/schwab/investing/accounts_products/investment/annuities/income_annuity/fixed_income_annuity_calculator
« Last Edit: December 19, 2019, 06:10:51 PM by Fuzz »

cangelosibrown

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Re: small biz owners - any self-funded defined benefit plan stories?
« Reply #1 on: December 24, 2019, 09:58:55 PM »
My uncle did this, I've heard him talk about it, but obviously don't have the full details. Sounds like he was able to do this and sock away a huge amount (at least a couple million) into a pension plan, which he then converted into a IRA once he stopped being able to contribute and dissolved the plan.

But, sounds like it was a huge hassle and expense too. He had to pay an actuary to sign off on the plan and what he could contribute to it, had to keep very detailed records, and I think at some point he was worried he was going to end up with too much money due to investment returns and pay a penalty...

He still thinks he came out ahead, and probably slightly more so now that he RMD age has been raised, but it definitely wasn't simple.

px4shooter

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Re: small biz owners - any self-funded defined benefit plan stories?
« Reply #2 on: December 28, 2019, 09:28:07 AM »
I wish I heard about this earlier in the year. Seems like an interesting concept and a good way to forego the taxes on the current income.

Already doing the SEP-IRA for the spouse and I am just straight eating the taxes on the business income, which is added to my wages. I need to look into this further for next year.

SwordGuy

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Re: small biz owners - any self-funded defined benefit plan stories?
« Reply #3 on: December 28, 2019, 09:51:49 AM »
If you have no heirs you want to pass money onto (other than spouse, and that will cost you), annuities could be great.

If someone can't be trusted not to blow thru their inherited money in short order, giving them an annuity instead could be great.

In theory, your sequence of returns risk is minimized simply because other people contributed and died off early, leaving a bigger pile of investments for you to live on.

The inability to pass on that wealth to my children is a show stopper for me.

Fuzz

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Re: small biz owners - any self-funded defined benefit plan stories?
« Reply #4 on: December 29, 2019, 03:32:55 PM »
@px4shooter - if you do this, let us know.
@SwordGuy - it's definitely an issue that annuities aren't heritable. however, the schwab annuity I referenced would pay out to either primary or the spouse. If they both die within 20 years, then there is a cash payout of 600K to the estate (at least that's how I read it). In the early death scenario, the annuity is a money loser for the holders and heirs. However, I think a neat way to go would be a mix of annuities and investments. The other risk with an annuity is that you're not inflation protected. So 5K/month in 5 years covers your rent, while 5K/month in 40 years might not.
@cangelosibrown that is exactly the kind of story I am looking for. Interesting. I did a bit of googling and I can't find an "off the shelf" defined benefit plan set of documents. It seems like the sort of thing that would be a good fit for a FIRE-minded high income service providers--like the lawyer, doctor, consultant or dentist that owns a practice and has a high income/high tax burden.

FatFI2025

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Re: small biz owners - any self-funded defined benefit plan stories?
« Reply #5 on: December 29, 2019, 08:17:12 PM »
So, as a small biz owner, I get 1M in income in a year. I decide to set up a defined benefit plan rather than contribute to my 401K. I go get documents to set up a plan  (where? how?). Then I go to Schwab and spend 1M to buy an annuity that pays out $5600/month for the rest of my life, starting in 20 years. That annuity costs 1M, so I don't pay any taxes on that income for the year.

A few points to clarify... 1) In a traditional defined benefit plan (pension), you create the annuity through multiple years of contributions and investments. I suppose you could buy a series of annuities every year as you contribute, but that would be unusual. The more popular option for small businesses are a cash balance plan where you terminate the DB plan and roll the value into a free 401k or IRA. 2) DB plan contributions are in addition to 401K contributions, but depending on the business type, contributions to a DB plan can lower the contribution limit to the 401K. 3) Annual contributions are age dependent and max out around $250K/yr.

This is a popular strategy so there are many providers online to check out and compare a few quotes.

Does anyone know anyone who has done this? If you were both a high earning business owner and a mustachian, wouldn't this make the most sense? Once you get the defined benefit plan paid for, then you're done.

My dad did it so that's why I know about the strategy. But it's also covered at https://www.whitecoatinvestor.com/cash-balance-plans-for-solo-and-group-practices/. I just did a consultation with an actuary and will setup a plan in late summer if all goes well for the business.