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Retirement Plan Options for a Consultant

| May 22, 2017
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We recently had the pleasure of sitting down with a client who is transitioning from long-term employment to becoming a small business owner (a consultant).  Historically, his employer provided the infrastructure for retirement savings and benefits, so he wanted to explore his options to see what would be the best fit for his company.  Focusing on his retirement savings options, let’s assume he is over 50 years old and (to illustrate his maxing out plans) he will earn $270,000 annually (after overhead; no taxes have been paid).  Further, he will have no employees (the retirement plan structure probably changes as he begins to add employees). What follows is a very limited discussion of his options (using 2017 limits):

  • SEP IRA (NO ANNUAL ADMINISTRATION) (approximately 20% of self-employed income): $54,000 max contribution
  • SIMPLE IRA (NO ANNUAL ADMINISTRATION): $12,500 plus $3,000 “catch up”:  $15,500 max contribution
  • Solo 401(k) (REQUIRES ANNUAL ADMINISTRATION): $18,000 plus $6,000 “catch-up”:  $24,000 max contribution
  • Other/Combo Defined Contribution plans (401(k) is a type of Defined Contribution plan) (REQUIRES ANNUAL ADMINISTRATION): total may not be more than $59,000 and can come from a combination of 401k and profit sharing.  For example, you may have a 401k ($24,000) and the profit sharing plan will pick up the difference ($35,000), since it’s less than 20% of income.
  • Defined Benefit/Cash Balance (REQUIRES ANNUAL ADMINISTRATION): This is the most fun option and the most complicated. Our estimates are that this client’s maximum contribution to a Cash Balance Pension Plan, for 2017, could be as much as $140,000.  In addition, he may be eligible to contribute up to $24,000 to a 401(k) plan, for a total contribution of $164,000.  In this scenario, he might have to use some of his current after-tax savings for living expenses, but the opportunity is there to protect a large portion of earnings from unnecessary taxes. 

As this will be his first year in business, our client chose the ease of a SEP-IRA.  He can setup a monthly draft with us and the funds will go straight into his chosen investments.  However, as his company grows, we will continue to explore ways for him to accelerate savings (and defer taxes). 

Our client is especially interested in how option #5 could work.  He’s not alone.  At many area Professional Firms, complaints arise regarding Defined Contribution (i.e. 401(k) and Profit Sharing Plans) limits and their inability to suit participants once retired.  High-earning professionals worry whether a savings limit of $59,000 per year (for those over 50) will provide the lifestyle to which they and their families have become accustomed. 

The ideal candidates for a Cash Balance Plan have the following characteristics:

  • Professionals seeking a contribution of more than $59,000 to their retirement plan or making more than $250,000.
  • Highly profitable companies with a relatively consistent profit pattern
  • Family and/or closely held businesses (succession planning).
  • CPA Firms, Medical Groups, Law Firms, Architects, etc. Neglecting retirement savings while building a practice leaves little time to build savings.
  • Older owners who need to catch up on their retirement savings.

The principal advantage of the Cash Balance Plan, when compared to Traditional Defined Benefit Plans, is that participants know what is going into the plan on their own behalf and what will come out upon leaving the firm.  Knowing that you will receive what you put in is of utmost concern to most participants.  Vesting is generally not an issue, as most professional firms make certain that partner accounts are 100% vested. 

Because Cash Balance Plans allow such large contributions, they require special attention and require special documentation.  Actuarial services are required for these types of plans as the formulas involved require a level of consulting only previously found in Traditional Defined Benefit Plans.  These plans, while more expensive to administer than a 401(k), are quite a bargain due to the benefit they provide. 

For professionals who wish to increase their deferral of taxable income and increase contributions into a qualified retirement plan, the options available present a significant opportunity that must not be ignored.  Our team of qualified advisors stand ready to help; please call either location to let us know how we can assist you.

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