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Small Business Pension Plans – A Retirement/Tax Savings Tool Easily Forgotten

Pension plans, also known as defined benefit plans, have been around for a long time and quite honestly don’t make sense for many businesses. For a small business with excellent cash flow, pension plans may be a perfect fit to shelter away big time tax savings. It can be easily overlooked when discussing retirement options such as SEPs, 401Ks, Simple IRAs, etc.; however, pension plans offer more opportunity than any other retirement vehicle for business owners and entrepreneurs to keep a larger share of their wealth out of the government’s pocket.

Any small business owner generating more than $250,000 a year in income should at least review if a pension plan makes the most sense, even if they already have an existing 401K or retirement account. An ideal candidate for pensions would be

  • A family run business with 1-5 employees
  • A single owner who serves as the sole employee for the business
  • Employers with significantly all part time/seasonal workers

Like 401K plans and IRAs, pension plan contributions are tax deferred for small business owners, but unlike 401Ks and IRAs, pension plans have a greater level of flexibility and higher contribution limits. By utilizing a pension plan, it’s possible for small business owners to stow away up to $215,000 in a single year as compared to only $18,000-$24,000 with a 401K. It’s not unusual to see 2-3 employee sized businesses contribute $300,000 to $400,000 towards their pension in a single year.

Some calculations are required and performed annually by a plan actuary to calculate funding options for defined benefit plans. These calculation costs can result in higher overall fees compared to other retirement vehicles however most clients that have a pension plan find the pension cost becomes a small burden compared to the reward of asset protection, greater flexibility, and maximized tax savings. Also, for those who need a high level of liquidity as working capital to keep their businesses running, pension plans may not always be the best retirement vehicle.

If you start a pension plan, you can take a credit of up to $500 a year for each of the first three years of the plan. The credit is for 50% of certain startup costs you incur in each of those years. Those costs include the expenses you incur in establishing and administering the plan, as well as the cost of any retirement planning education programs you sponsor for your employees.

If you had a pension plan in the last couple of years, you would not qualify for the credit unless waiting three years from the time the plan was terminated before starting a new plan. As an example, if you had a plan that was terminated in 2013, you would have to wait until 2017 to start a new plan and qualify for the credit.

If a pension plan does not seem appropriate for your business, there are several types of plans you can establish for your employees and still qualify for the credit. For example, you could start a SEP (simplified employee pension), profit sharing, or an annuity plan, among other choices.

Small business owners considering a pension plan as a viable option should seek out a qualified advisor that works with pension plans and can share in detail further pros and cons of a pension plan. As always, we are more than willing to have such conversations with you to see if a pension plan would be a good fit.

Jess Weaver

Jess Weaver

CPA at Ketel Thorstenson, LLP
Jess is originally from Spearfish, SD. He started working for Ketel Thorstenson in January of 2010 shortly after passing his CPA exam. Jess graduated from Black Hills State University with a professional accountancy degree.
Jess Weaver

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