Pension Plans – A Possible Option for Small Business Owners

Written by: Martin X. Shields

When most people think of a pension plan they picture a large company or government entity that has thousands of employees and where the plan is designed to provide retirees of the organization a monthly paycheck that will vary based on length of services and pay level. While this has been the traditional definition of a pension plan it is more common that these plans are being slowly replaced by 401(k) or 403(b) plans that shift the responsibility of preparing for retirement from the organization to the worker. It is also the case that very small companies are starting to put pension plans in place as an added benefit for their workers and to lower the income tax liability for owners of small companies.

 
Pension plans are also known as defined-benefit plans and the reason you see more small businesses (usually companies with less than 5 people) establishing these plans is that it can allow an owner of a company to contribute significant amounts of pre-tax income (varying from $100,000 – $250,000 annually) into a tax deferred account. An additional benefit of these plans is that if there is more than 1 person participating, all contributions to the plan are creditor protected. In most cases, after 5-10 years of contributing to the plan, the small business owner closes the plan and all the assets in the plan are moved into qualified IRA accounts for the plan participants with no tax consequence from the transfer.

 
In order to put a defined benefit plan in place, there are some requirements that need to be met on an annual basis, including paying to have an outside firm complete the actuarial calculations and federal filings for the plan. These requirements also include making annual contributions into the plan for employees. To minimize the contributions an owner will need to make on behalf of the employees, the optimal situation is when the owner is significantly older than the employees. The final requirement is that once the plan is established, the company will need to contribute a minimal amount of dollars each year to the plan so it is important that the company have predictable cash flow.

 
Before a plan can be implemented, a plan design needs to be completed to insure that it meets all the IRS requirements and the design will also provide the business owner an idea of the tax savings and costs of the plan. For the small business owner who can meet the requirements listed above and who is looking to substantially lower their income tax liability, implementing a defined benefit plan can be a great benefit for both the owner and the employees of the company.