If you own a small business with just a handful of employees, and are worried about saving enough for retirement, here’s an idea: start an old-fashioned defined benefit plan for your company.
Sure, sure, everyone knows the defined benefit plans (a.k.a., DB plans) are passé, the creatures of large corporations, now being phased out. In the past, the DB concept seldom filtered down to small businesses. That’s not the case anymore, for good reason.
Under a DB plan, you get a set pension payout for life, based on your contributions and years of service. The beauty of this, for an entrepreneur, particularly one with good cash flow, is you can boost your personal retirement income enormously.
Another good thing about DB plans is they make employees happy, helping productivity and retention. Large corporations started offering them in World War II, as substitutes for wage hikes, which were mostly non-existent due to wartime wage-and-price controls. In the post-war boom years, the late 1940s through the 1960s, they were an additional perk. But then, as managers looked to cut costs, they have been on the way out.
For that reason, DB plans are increasingly used for businesses that have just a few employees. That’s a counter-trend to what’s happening in many large corporations, where DB plans are being frozen (no new employees allowed in) or phased out with participants getting lump sums or annuities.
Contributing to a DB plan has the added benefit of lowering your company’s taxable income. And, perish the thought, should your business fall into Chapter 11, the DB trove is off-limits to creditors.
As a business owner, you can invest more in a DB plan for retirement than a typical IRA or 401(k) permits—well north of $100,000. This year, a 401(k) has a contribution ceiling of $19,000 (and for the age 50 and up crowd, an extra $6,000 in catch-up payments).
Even better, as a DB plan participant, no law stops you from taking out other kinds of retirement plans, as well. You can still start an IRA, a 401(k) or both. With the DB plan, as with an IRA and a 401(k), the invested money enjoys tax-deferred growth. When it comes time to tap the accounts in retirement, of course, all withdrawals are taxable at ordinary income rates.
One important thing to note: Doing a DB plan for your company is not cheap or easy. DBs don’t require that employees contribute to the DB plan. That means the money comes from you, as the business owner. Annual contributions are based on actuarial assumptions, chiefly the participants’ ages.
And the amount that the company pays into the plan can’t vary with the state of your business’ revenues. If a recession harms your finances, tough luck. Paring your contribution is a no-go. You owe that given amount to the plan, no matter what.
What’s more, the paperwork and the administration fees can be up there where the air is rare. All beneficiaries, for instance, must be provided with an annual summary of the plan’s financials. In general, if a plan’s assets fall below 70% of what’s necessary to fund all the pension payouts, the U.S. Department of Labor will be asking some tough questions. Then, you’ll need to up your company’s contributions to the fund to make it more financially stable.
When your employees get their gold watches, you have a legal responsibility to see that they are paid the pensions that they have earned.
On the other hand, when it’s your time to hang it up, the nice income stream from the DB plan may well make all the hassle worthwhile.