How to Avoid Saying "I gave to the IRS."

It’s the last quarter of the year again and usually this means meeting with your accountant for year-end planning and tax minimization.  The question that business owners most often ask is,

Can I put more tax deductible dollars into my retirement plan just for me?”  Given the proper employee demographics and planning, the answer is a resounding “Yes”.

Cross-Tested Retirement Plan

The first and most widely used technique is a Cross-Tested retirement plan.  It has been described as a hybrid, a cross between a Defined Benefit and a Profit Sharing Plan.

In general, it will allow a business owner to establish a custom-designed, tax deductible retirement plan in his or her favor without being deemed discriminatory by the IRS.  The reasons?  The owner is usually older and makes more money than the employees.  A rough formula for calculating the contribution is 25% of the owner’s compensation – to a maximum of $50,000 – plus 5% of total employee compensation.

However, there may be significant flexibility with this type of plan, depending upon demographics.

From Example 2, you can see that the built-in flexibility may still generate significant contributions without having to maximize the owner’s W-2 compensation.

In addition, 401(k) features may be added to allow employees the option of deferring their pay for retirement, if desired.

Defined Benefit Plan

The second approach is a Defined Benefit Plan.  These types of plans first became popular in the post- World War II industrial boom.  They define specific monthly or yearly income that a retiree will receive for life.  Hence, the term Defined Benefit.

The maximum annual retirement benefit payable under such a plan is $195,000.  It takes a large pot of money to be able to pay someone that much retirement income each year, which means big up-front deductions.  It also allows the plan to exceed the previously described $50,000 annual contribution limit for an individual.

In our next example, a 45 year old owner would be able to have his or her company put away an additional $108,000 maximum before tax just for the owner with a minimal contribution for employees.  Thus, the total contribution in the owner’s behalf could be $158,000 ($50,000 + $108,000).  Plus the older the owner is, the larger the annual maximum becomes.  If another goal is to provide larger contributions for other employees, this too may be accomplished.

As an important planning note, the contribution does not have to be maximized.

Once again, the appropriate demographics can produce interesting results.

In one example, a highly compensated 49 year old business owner with no employees other than himself was able to establish a plan with a $78,000 annual contribution just for him.

A second situation enabled a 57 year old business owner to establish a plan where $144,000 of the contribution went to his wife and to him, with $18,000 going to their employees.

Another important note:  If your employees are unionized, generally it is not necessary to include union employees in your plan because they are covered by a collective bargaining agreement.

These plans are custom-designed.  They require the services of a team of advisors and, in general, have higher annual maintenance costs.  Because the savings can be so dramatic, the extra costs are miniscule by comparison.

The point is . . . . . . opportunities still exist that enable you to put away significant dollars before tax, given the right circumstances.  But, you must act before year end.

What are your options?

• Do Nothing – Continue your present course and leave tax dollars on the table.
• Be Proactive – Use the team approach consisting of a financial services firm, attorney and accountant to explore and take advantage of those options the law allows.

In our experience – Awareness and planning outperform ignoring the situation every time.

Wayne D. Minich, CLU®, ChFC®

David R. Minich, CFP®, CLU®

Financial Advisors to the Construction Industry since 1971