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Defined Benefit Plan for Self Employed

Ema_Jack
in Fund Discussions
Hello,
I am self employed, and 50 years old. My business started picking up in the last two years and this year I will have significant cash flow which I want to put in a pre-tax account. I have heard that a defined benefit plan can help me contribute as much as $250,000 per year.
However, during the discussion with the actuarial firm, I was told that the investment return of the plan should be low or kept low. This prevents over funding the plan and sizable contributions can be made each year. If the investment returns are high, the size of the contributions can decrease.
Has anyone in this forum encountered this situation before? I am not sure it is wise to invest money at 3-5% growth rate when the market returns are higher.
Thanks.

Comments

  • msf
    That sounds about right. I believe you could instead project a higher ROR and contribute less. You would still fund the pension plan up to the IRS limit ($225K/year pension @retirement). You would invest for higher returns and wouldn't even have to contribute as much to get the same level of benefits. But see below for risk.

    Are you sure that you were being told that you should not invest for higher return, or did your actuaries say that they would use a lower rate of return for projections? They have to use a credible ROR for projections to determine the max you can contribute. The object is to reach the max permitted balance at retirement. The lower the assumed ROR, the more you can contribute, at least initially.

    Regardless, the amount you can/must contribute is recalculated annually. If you project a low (but credible) ROR and perform better, your subsequent contributions will be reduced. If you project a higher (still credible) ROR and underperform, your subsequent min contribution requirements may be increased, possibly substantially.

    I trust the actuaries explained to you how you are committing to maintaining high contribution levels for several years (otherwise you risk seeing the IRS disqualify your plan).

    Here's a 2016 guide from from Schwab with an example of someone age 55, planning to retire at age 65. (See p.3). Schwab also uses a low projected ROR (here, 3.98%). Note that because you're younger (presumably with more years to retirement), all else being equal, you'd be able to contribute less than the $166K shown. So I'm curious where the $250K figure you gave came from.
    https://www.schwab.com/public/file/P-1604569/SLS25840-05-ST.pdf
  • johnNjohnN
    edited July 2019
    Hi msf thx... What firms do you recommend for db plans? Vanguard

    Hi ema

    I believe you can have 401k and distribution 18 or 20k annually and you can buy higher aggressive stocks funds in these

    My tax adivesor states same as your thoughts have to be 5 or 6% annually returns or you may run into tax issues irs issues


    If you don't like plans you can switch to sep-ira 5 yrs later this is what Vanguard advisor told me (56k distribution 2020)
  • msf
    2019 contribution limits are:
    401(k): $56K + $6K (catch up) = $62K
    SEP: $56K (no catch up provision)
    https://www.irs.gov/retirement-plans/cola-increases-for-dollar-limitations-on-benefits-and-contributions

    The IRS has not yet announced 2020 figures for retirement plans. If Vanguard provided contribution limits for 2020, they were projections.

    Projected for 2020:
    401(k): $57K + $6.5K (catch up) = $63.5K
    SEP: $57K (no catch up provision)
    https://thefinancebuff.com/401k-403b-ira-contribution-limits.html

    Again, see Schwab example cited above for comparison between SEP and DB plan. (For a fair comparison, you need to account for the earnings that are added to the DB plan but not to the SEP. This significantly reduces the gap between the two.)
  • Ema_Jack
    Thank you everyone. I came across another website that has detailed information about defined benefit plans. They also have an online calculator and now I understand the concept of lower investment returns much better.
    If anyone wants to have a look at the article:
    http://www.pensiondeductions.com/comprehensive-guide-to-defined-benefit-plan/
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