“I want to run something by you,” Gary said. He settled into the slick leather chair directly across from Charlie, his tax consultant for the past 25 years. The office was quiet.
“My new financial advisor mentioned a tax savings strategy that sounded too good to be true.”
Gary, an owner of a successful consulting group, leaned forward. His voice carried a hint of urgency: “If it’s that good, why didn’t my previous advisor mention it? Why didn’t you tell me about it?”
Charlie blinked, momentarily at a loss for words. “What strategy?”
“A defined benefit plan.”
Charlie had heard of defined benefit plans, but he had never delved into them deeply. While he learned about traditional pension plans in school, defined benefit plans remained on the periphery of his knowledge.
Recognizing the potential benefits for his clientele — independent professionals, consultants, and small business owners, all who wanted greater tax savings — Charlie took a crash course on defined benefit plans.
Here’s what he learned:
There really are significant tax savings.
Defined benefit (DB) plans offer substantial tax savings, which can be particularly beneficial for high-income clients. For example, a high-income individual contributing $250,000 annually to a DB plan could save approximately $100,000 in taxes each year, assuming a combined federal and state tax rate of 40%. Over a decade, this could result in total tax savings of $1 million, allowing significant reinvestment or reallocation of resources that would otherwise be paid in taxes.
Investment choices can be tailored.
High-income clients often worry about the returns on DB plans compared to traditional investments. Within a DB plan, though, investment choices can be tailored to the client’s preferences and risk tolerance, potentially matching or even exceeding the performance of other investments. For instance, a well-managed DB plan could yield annual returns of 5-7%, comparable to many traditional retirement accounts, but with the benefit of deferring additional amounts of taxes.
Tax savings improve retirement savings.
When advising clients on DB plans, it’s crucial to highlight the overall financial benefits rather than focusing solely on gross returns. For example, if a client earns $500,000 annually and invests $250,000 in a DB plan, their taxable income could be reduced to $250,000. The resulting tax savings can significantly improve the client’s net financial position. This approach not only boosts retirement savings but also enhances overall tax efficiency.
Contributions are flexible.
Each year, clients must evaluate their available cash and determine the optimal contribution amount to their DB plan. For instance, if a client has a fluctuating income, they might contribute $200,000 in a high-income year and $100,000 in a lower-income year. This flexibility allows clients to maximize tax benefits while aligning contributions with their financial situation and goals.
It creates stability and security.
Beyond tax savings, DB plans offer a sense of security and stability. For example, a client with a DB plan might secure an annual retirement income of $100,000, providing a reliable and predictable source of funds that is less affected by market volatility. This stability is crucial for clients seeking a balanced retirement strategy that mitigates risk while ensuring a steady income stream.
Clients look to expertise.
Clients need to trust their advisors fully when considering a DB plan. Many, though, may not have been aware of this option due to previous advisors lacking expertise or not being proactive in exploring all financial planning avenues. As a knowledgeable tax professional, you can provide the expertise and proactive guidance that high-income clients need to embrace a DB plan confidently.
This entails establishing relationships with trusted partners, such as actuaries and financial advisors, who can help facilitate the setup and management of DB plans. The most successful tax professionals also keep up with the latest tax laws and regulations affecting retirement plans to provide accurate and up-to-date advice.
