Tax & Legal Advice
Tax-Law Changes Will Help the Self-Employed
For high-income small-business owners, the time may be ripe to sock away serious retirement money, thanks to the new appeal of defined-benefit savings plans. Here's how to cash in.
For self-employed high-income earners, the time may be ripe to sock away serious retirement money.
Pioneer Investments, the asset-management division of UniCredito Italiano, will announce this week that it is rolling out a defined-benefits plan that is built for small businesses that have no more than five workers, joining a handful of other firms that have rolled out similar plans. The new plan is likely to be especially popular with companies employing just one worker--the owner.
Defined-benefit plans have been around for years but they've lost popularity to 401(k) plans, which are less expensive for employers to administer. That's been particularly true with small businesses. Some recent tax-law changes, however, have made contributions to defined-benefit plans more attractive for small-business owners. For example, the Economic Growth and Tax Relief Reconciliation Act of 2001 raised the maximum benefit amount that could be paid out from these types of plans and reduced the age at which retirement benefits could be received.
Pioneer says high-income earnings can tap into those tax-law changes through its new plan, dubbed the Uni-DB Plan. Defined-benefit plans, unlike defined-contribution plans such as 401(k) plans, are primarily funded and managed by the employer.
The tax savings from Uni-DB can indeed be substantial, at least for people who don't need their income for standard living expenses. This year, a 52-year-old individual earning $200,000 a year and planning on retiring in 10 years, can contribute just over $150,000 in tax-deductible contributions to the plan. That stands in stark contrast to the maximum $44,000 (including the additional $3,000 for catch-up contributions) self-employed individuals can stash away annually under a 401(k) or profit-sharing plan.
Based on those contributions and assuming a 40% tax bracket, annual tax savings amount to $62,141 for the DB plan, compared with $17,600 for the 401(k) plan. The amount that can be contributed each year can vary, depending on a complex set of actuarial calculations that takes into account age, the average of the three highest years of income, planned retirement age, and the balance accumulated in the plan.
Pioneer's bundled plan offering--along with similar types of plans already offered by firms such as Hartford and UBS AG--is sure to raise the profile of these plans and is likely to mean that other financial-services companies soon will follow suit with their own versions.
But the solo plans, which owners can buy only through financial advisers, aren't for everybody. An individual who opens a plan is committed to making the required annual contributions to the plan to fund a retirement goal.
"You don't enter into it lightly. ... It's a bit like a marriage," said Jodie Hale, Pioneer's vice president and director of retirement plans marketing. Under adverse business circumstances, however, individuals are allowed to adjust their contributions. And if the plan is terminated before five years, the IRS could disallow contributions, said Lisa Dummer, an attorney specializing in ERISA issues and a consultant at Metavante Corp., a banking-technology company, which will act as Pioneer's third-party administrator.
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