Wealth Matters: Defined-Benefit Plans Allow Fast Retirement Saving, but With Risks

So I couldn’t help but be skeptical when I was told about a plan aimed at small-business owners in their 50s who have saved little for retirement but can now afford to put aside a lot of money each year. They can then deduct that money as a business expense, resulting in a significant tax savings.

But I checked with the Internal Revenue Service, and the plan is indeed legitimate.

It is a defined-benefit plan, much like the one large employers once regularly offered their workers, that guarantees a set monthly payment in retirement. In this case, though, the plan works best for really small businesses — those that employ just one or two people.

The I.R.S. allows a maximum annual contribution to the plan of about $255,000 for people in their 50s. (For younger workers, the contribution limit is lower, because the calculation is based on the number of years until retirement. In some cases, the limit is so low that other retirement savings options might be better.) Total holdings in the plan are limited to $2.3 million to $2.4 million, enough to cover the maximum allowed payment in retirement of $200,000 a year.

Advisers said the plans were less effective in companies with more employees, particularly older ones, because the owner would be required to make contributions for all of them, and at a high level, since older employees are typically better paid and closer to retirement. (If the additional employees were young and low-paid, the cost of offering the plan to them might be low enough for it to make sense.)

“It’s not too good to be true,” said Lisa C. Germano, president and general counsel at Actuarial Benefits and Design Company in Midlothian, Va. “But you need to be able to fund the plan and fund it for an indefinite period. It’s a commitment. That’s one of the reasons you get the reward.”

Some advisers like Ms. Germano were worried that, like other generous deductions, this one could be threatened in the current tax and budget negotiations. But regardless of how the talks in Washington turn out, this is still the time of year when many small-business owners need to decide whether to set up a defined-benefit plan or stick with more traditional forms of retirement savings, like SEP I.R.A.’s for the self-employed or a profit-sharing plan.

Here is some of what I learned.

UPSIDE Defined-benefit plans are mainly a way for small-business owners who neglected to save for retirement to catch up. The ideal candidates can put away $100,000 to $150,000 a year for at least 10 years, said Leigh Goldblatt, vice president and chief compliance officer at Glazer Financial Network.

This was the case with John Rogers, a Denver businessman. “I was in my late 50s and I didn’t have a penny saved for retirement,” he said.

He lost his life savings in his 40s, he said, in a recycling company he started with friends. He also raised six children, four of whom he said he put through college.

But by 2006, he was six years into being an independent contractor for Univera, a company that makes nutritional supplements. (The company’s sales model is similar to Amway’s, where people like Mr. Rogers sell to individuals or find other people to sell for them.)

With his business providing steady, predictable income — he and his wife are ranked as top sellers for the company — he wanted to start saving. He said a defined-benefit plan was attractive for both deferring taxes and for saving for retirement.

“Our adviser tells us at the beginning of the year what we have to contribute,” said Mr. Rogers, 63. “We’re very disciplined. We pay our defined-benefit plan first and then our business expenses.”

But even though the I.R.S. assumes the plan will make monthly payments in retirement, which is why it allows people to save so much over a short period of time, owners shut down most of these plans and roll the money in them to a regular retirement account, said Mr. Goldblatt, whose firm advised Mr. Rogers. This reduces expenses and gives the owner control over how to withdraw the money.

DOWNSIDES Such a chance for a retirement savings do-over, as it were, does not come without catches. And skeptics say these plans lure people with the prospect of quick and large retirement savings without discussing the risks.

Article source: http://www.nytimes.com/2012/12/01/your-money/defined-benefit-plans-allow-fast-retirement-saving-but-with-risks.html?partner=rss&emc=rss