Whether you are a business owner or employed, you will need to retire at some point. As a small business owner with employees, you are also responsible for setting up a retirement plan for yourself and your employees.
A defined benefit plan allows small business owners an avenue to save more money for retirement than traditional retirement options. Unfortunately, there is a lot of misinformation about defined benefit plans.
Below is a list of four common misconceptions about benefits plans for small business owners that you may need to know.
The plan causes a strain on cash flow
As a plan sponsor, you will realize that defined benefit plans are administratively costly compared to 401(k) plans. However, many do not realize that you also enjoy higher tax benefits in years of high cash flow than you would under a 401(k) plan.
These tax benefits are intentionally created through government policy to incentivize business owners and high-income partners to prepare for their retirement rather than depend on public welfare. In other words, benefit plans place a business in a lower tax bracket, meaning that the owner and their partners can unquestionably keep a more significant portion of their profits.
If your business can afford to contribute a substantial amount consistently, a defined benefit plan may be the best choice for you. But if you are yet to make up your mind, this guide on defined benefit plans for small business owners can help make it clear for you.
The plans are rigid
There is a considerable misconception even among financial advisors that defined benefits plans are highly rigid. This is not entirely true. However, before establishing a plan, it is crucial to establish that you can fund it annually.
However, you can adjust contribution amounts each year according to the value of assets in the plan. For this to work best, it would be best to revise your contributions upwards when the returns are good, which can help reduce future contributions in case returns decrease in the future.
It is important to note that changing your plans will incur some cost towards designing a new benefit formula and drafting documents for signing. If your business suffers severely such that making contributions becomes impossible, you may also opt to terminate your plan.
There are no minimum contributions
The IRS has stringent minimum contribution rules for defined benefits plans. Before signing up for a plan, it is crucial to ensure that you have a steady income. It is important to note that there is a big difference between a defined benefit plan and a profit-sharing plan where sponsors can stop contributions in some years.
Failure to meet the required minimum contribution results in IRS imposed taxes, plan disqualification, and disallowed past tax deductions. Defined benefit plans are primarily ideal for individuals with a net income of more than $250,000 per year to ensure that the cost of running the plan is low relative to the tax savings.
Every employee must be covered
Like a 401(k) plan, not every employee needs to be covered under a defined benefits plan. The retirement plan nondiscrimination rules exclude highly compensated employees from coverage.
However, the law requires that every less highly paid employee working for more than 1000 hours per year be a beneficiary under the plan.
Final thoughts
Defined benefit plans are a great way of preparing for retirement for the self-employed.
Now that you are aware of some of the most common misconceptions around it, there is no reason why you shouldn’t choose a defined benefits plan as your preferred retirement savings option.
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