Small Business Continuation Plan – A Creative use of a Split Funded Defined Benefit Plan to Solve Tax and Retirement Funding Challenges

Situation:

A husband and wife in their mid-60s have a successful business which employs 14 staff, inclusive of a son and daughter (ages 36 and 38). The owners and the children have been making contributions to a 401(k)/profit sharing plan. Recently, the owners have begun to discuss retiring in 5 years and passing the company to the son and daughter. Additionally, the need for increased income tax deduction was raised by their CPA.

Need:

While the owners were eager to retire, they realized that they had taken much of the company profits and invested it back into the business. Furthermore, they had depleted much of their savings by funding the educations for their children.

To make up for the savings shortfall, the owners desired to contribute about $600,000 per year, PRE-TAX, for the next 5 years, to a custom pension plan. The plan needed to address three concerns: 1) quickly accumulate retirement income, 2) contributions had to be income tax deductible, and 3) in addition to managed assets, the plan needed to include life insurance in order to protect the wealth transfer. If the three concerns could be addressed, the company could pass to the children effectively and the clients would have sufficient income for retirement.

Solution:

A custom plan was implemented as follows:

· Total 401(k) for the owners: $48,000

· Total Split Funded Defined Benefit for the owners: $550,000

· Required contribution for the employees: $43,000

· Total Company Tax Deductible Contribution: $641,000

In a 45% tax bracket, the $641,000 represented a tax savings of about $289,000 with the owners realizing about 94% of the contribution for them.

Bringing It All Together

The owners were able to make significant contributions on a fully deductible basis thereby securing their need for income replacement in retirement as well as creating a successful transfer to children.