Why Give It to Uncle Sam When You Can Keep It? (November 2007)

Dominick Paoloni

What if you could recommend a qualified plan to your clients that can remove hundreds of thousands of dollars from their reportable W-2 income each year, along with that of their select employees? And what if this plan also saved your clients thousands of dollars in payroll taxes each year?

These propositions could seem outlandish—how can successful business owners exceed the current qualified plan contribution limits laid forth by the IRS ($45,000 for 2007, $50,000 for 2008)? Most advisors throw up their hands and surmise nothing more can be done to increase the amount their clients can contribute to their qualified retirement plans.

Many investors don’t realize the IRS has loosened discrimination laws regarding qualified plan contribution limits and allowed businesses to access qualified plans with fewer restrictions over the last few years. Businesses can combine a Defined Contribution plan (401k) and a Defined Benefit plan (DC/DB) under the same corporation. And in doing so, they can highly skew the plan design and contributions made to favor the business owner. Combination plans can also create a high degree of flexibility for plan participants.

In addition to these important benefits, the real home run gained by combining DC/DB plans in a business is that the owners and/or the highly compensated employees can bury hundreds of thousands of dollars every year away from their balance sheet and avoid taxes on that money. The assets invested in these plans can compound more significantly and be diverted away from Uncle Sam to build a heartier retirement faster.

How Does a Combination DC/DB Plan Work?

Recently a client of our firm was complaining about the contribution limits allowed by his 401(k). After making his annual 401(k) contribution and receiving a paltry 6% corporate match, our client was still left with a sizable W-2 income—taxed in the maximum bracket. He wanted to be able to save more for retirement and to pay less in taxes so we conducted an analysis to explore the possibility of implementing a custom DC/DB combination plan for his corporation.

With our proposed plan, our client was able to reduce his reported W-2 income by 80%. The diverted income, including a sizable chunk that was otherwise slated for the IRS, was invested in a well-diversified investment portfolio that he will use for retirement.

Using combined DC/DB plans allows your business-owning clients to save a great deal in taxes, sock away more for their retirement, and divert income away from Uncle Sam and back into their pockets. This is like giving your clients free money.

If you would like to learn more about combined Defined Contribution/Defined Benefit plans or to receive an illustration for a specific client, you can contact us at 303-697-3174 or via email at info@investps.com