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How Combination Retirement Plans Create Business Tax Savings

How Combination Retirement Plans Create Business Tax Savings

It’s a question I get frequently: “My business is doing really well, but my tax bill has skyrocketed.  Is there anything I can do to reduce taxes?” 

As a Financial Advisor with a focus on small business owners, I am regularly in a position to help owners and CEOs think about their businesses.  While the conversations frequently hinge on succession, strategy, or management challenges, they just as often gravitate toward questions of estate planning and tax saving tactics for business owners. 

A couple years ago, I was out playing golf with a friend, and we were paired up by the Starter with a gentleman playing alone.  The three of us struck up a conversation, and were enjoying each other’s company, when at the start of the back nine, the single asked me about my job.  Upon hearing Financial Advisor as the answer, he said “You know, my company has seen an increase in sales and profitability the last 18 months, and I couldn’t believe the size of the check I wrote to the IRS last year.  My accountant doesn’t have any answers for how to reduce what I owe.”

I smiled and asked him a few questions about his business, his staff (he and his wife plus just four other employees), their ages, and whether he had a 401(k) or other retirement plan set up for the business (he didn’t, yet).  Owners of small businesses with few employees can often defer material amounts of their profit into qualified accounts by establishing what’s known as a combination (combo) plan.  A combo plancombines a Defined Contribution (401(k) Profit Sharing) Plan and Defined Benefit Pension Plan. Depending on the number and age of the employees, the combo plan allows the owners to set aside substantial numbers of dollars in tax deferred accounts as long as they also make relatively smaller contributions to employees’ qualified accounts.

I began further consideration on whether a combination plan would be the right fit for his business. Combination plans are best fit and offer optimal business tax savings when the firm has 20 or fewer employees who skew younger than an owner, who’s a little older and willing to help employees save for retirement in order to save even more for his or her retirement. This business fit the bill, and it seemed like a reasonable time to take the relationship further.

I brought in one of Genovese Burford & Brothers’ Third Party Administrator (TPA) partners, who helps set up the plan design and performs the actuarial calculations to determine the proportion of contributions that will satisfy the legal requirements for balance between high compensated and non-highly compensated employees. Together, we worked up a proposal for a combination plan that worked for the client.

For reference, here are a few things we ask clients searching for additional business tax savings to keep in mind when setting up a combo defined contribution/defined benefit plan of this type:

-          Must plan to operate the plan for at least three years

-          Must commit to a level of contributions the business’ cash flows can support, even in a down year

-          In a combo plan, while the 401(k) plan can be participant-directed (each employee contributes to their own account and decides their own investment strategy) or pooled (one general account invested with one strategy, with each employee having a partial share of the whole), there will need to be a pooled account for the company contributions to employees’ 401(k)s, and the defined benefit contributions will also go into a pooled account.

-          Important to understand that the pooled accounts will not have on demand accounting of balance by employee, but will only produce estimates once per year.

-          It’s important that your Financial Advisor communicate with your employees on at least an annual basis about the plan design, the investments, and how they benefit as a result of the combination plan.

-          These plans do have some costs to administrate, as the TPA will have one-time set up costs and ongoing annual costs for each plan, and the Financial Advisor will typically charge a fractional proportion of the assets under management to provide investment advice, employee education, and fiduciary risk management. 

-          We believe that a Financial Advisor with experience offering advisory services to both participant-directed and combination retirement plans can offer significant value, even when compared to advisors or brokers who focus solely on individual clients.

If you’re an owner and find yourself in a similar position searching for additional business tax savings, GBB would be delighted to have a conversation. Give us a call at (916) 924-7527 or complete our simple contact form.

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