If you’re a business owner or a solo entrepreneur, you have a variety of options when it comes to planning your retirement, paying your taxes, and avoiding penalties along the way.
With over 25 years’ experience working with business owners and CPAs, Brian Hartstein, Director of Corporate Development at Bayntree Wealth Advisors, helps his clients utilize their pre-tax dollars as effectively as possible.
Using his background in the pension business (he’s worked in his parents’ third-party administration firm starting in middle school) and with his knowledge of finance and taxes, Brian develops effective retirement plans to meet the specific needs of businesses of all sizes. We talked in-depth about different plan options available to entrepreneurs, corporate employees with side hustles, and everyone in between – and the major reasons why you should consider them.
In this podcast interview, you’ll learn:
If you enjoyed this podcast, Brian will be back on the podcast soon for another deep dive into financial planning!
Hi, this is your host, Andrew Rafal, the founder and CEO of Bayntree Wealth Advisors and I wanted to personally welcome you to Your Wealth & Beyond, a podcast that will empower you, the entrepreneur and business owner, with the insight and information you need to effectively manage and control your personal and professional finances. I’m going to help you focus on growing your business, building your wealth, and most importantly, finding purpose in what matters most.
[00:00:37] Andrew: Welcome, everybody, to another episode of Your Wealth & Beyond. I’m your host, Andrew Rafal, the founder and CEO of Bayntree Wealth Advisors. Today we’ve got a great show lined up. Actually, we have a special guest, Brian Hartstein, who is the Director of Corporate Development with Bayntree Wealth Advisors. He’s been an integral part of the growth of the company and he actually brings over 30 years’ experience working with business owners and families, CPAs and attorneys in helping to be as tax efficient as possible with your income. So, today’s show is going to center around you, as the business owner, some of the ways in which you can defer and put more money in your pocket each year and less to your business partner, Uncle Sam. Other areas we’re going to touch on are looking at why it’s so important to diversify your risk and not have all of your assets tied up in the business. So, we’re going to talk high level on some simple ways to save for retirement and then we’re also going to go through some more complex ways on how you can defer as much as possible. Without further ado, my episode with Brian Hartstein on being efficient with your income and saving for retirement.
[00:01:54] Andrew: Brian, welcome to the Your Wealth & Beyond Podcast. It is great to have you on today. How are you doing?
[00:01:59] Brian: I’m doing well. Thanks for having me, Andrew.
[00:02:02] Andrew: You know, as tax season just ended, or I guess today we got a special extension with the IRS website going down which I think that’s a first for me at least.
[00:02:11] Brian: First that I can remember a reprieve like that.
[00:02:14] Andrew: I don’t know. It must be those bots or something but I think for business owners and those of you that have been listening, we know that Your Wealth & Beyond Podcast is helping you build wealth and find purpose. Well, today we’re going to talk about building wealth and, Brian, I know with your background over 25 years of working with business owners and CPAs really your core specialty is helping people keep their hard-earned money and I think as any business owner, we face a lot of trials and tribulations but the one thing is how can we keep hold of more of our hard-earned money. So, today we’re going to go through tips and strategies and some of the things that you’ve seen for both small business owners, medium business owners, and larger business owners on how to defer as much as possible. So, Brian, give us a quick little recap of kind of your history in regard to helping business owners and your background in financial services.
[00:03:09] Brian: Sure. Thanks, Andrew. It’s interesting. Mine’s a little unusual since I grew up in the pension business and I worked in my family’s third-party administrator firm which helped business owners operate and administer pension plans going back to literally when I was in middle school so I probably wasn’t trained to do much of anything else but our primary focus even way back then was helping business owners utilize their pretax dollars as effectively as possible. So, I grew up in that business. I worked in finance. I have a pension and tax background and primarily focused in the business owner market in terms of helping them do their tax and financial planning alongside of their accountant or those in the CPA community.
[00:03:53] Andrew: Yeah. Which is interesting. For those listeners not in our industry, most financial advisors which Brian is and together working at Bayntree together we’ve helped protect a lot of clients build a roadmap, but most financial advisors don’t have the acumen nor the knowledge on the tax side. And obviously we’re not CPAs, Brian, but the fact that you actually get referrals from CPAs as kind of that holy grail meaning you know what you’re doing, and they respect and trust you so that’s one of the things that our business owner clients can really take a blessing and that we’re providing them that good advice. So, when we think about some of the areas and let’s focus first on the simple ways on how we can defer or put more money in our pockets. Walk the listener through, maybe they’re a sole employee. They’ve set up an LLC and it’s just them and now they’re starting to turn a little bit of a profit. What are some of the things that they can look at to help defer some of the taxes?
[00:04:50] Brian: Sure. We try to keep it simple as opposed to making it overly complicated when we’re trying to sell a business owner’s specific tax problem or help them with retirement planning. So, when you’re talking about that type of business owner, you’re probably looking at one or two areas to start. You’re looking at what’s called a SEP, a simplified employee pension, or perhaps what we call a solo 401(k) profiteering plan.
[00:05:16] Andrew: Okay. So, let’s walk through then each of those, kind of high level. So, many of us have come from as entrepreneurs the corporate world where we had the 401(k). The company offered it. We could contribute up to right now in 2018 it’s $18,500, over 50 it’s 24,500 and then if we were lucky, the company was matching us. The contribution to some company is at 3%. Some it’s 5%. Some it’s even as high as we still see 8%. Well, how does that differ than for an individual who started a business and they only have one employee and what is that solo 401(k) look like?
[00:05:52] Brian: Right. So, if they’re the sole employee, a solo 401(k) will let them put away the maximum deferral amount allowed by them into a 401(k) depending on the range like you said $18,500 if you’re below age 50 and then you have a higher amount if you’re above age 50 and you can use the profiteering component as well to put in an extra 55,000. You have the ability to do that with a SEP or you could defer up to 55,000 but that’s limited to 25% of compensation. Where with a solo 401(k) profit sharing plan, you can go up to 100% of compensation. So, depending upon how much of your compensation you would like to defer, one plan might be better than the other. The one limitation you always see with what we call a SEP is if you at one point are going to have any employees possibly working for you in the future, you probably don’t want to utilize that plan once that employee becomes onboard and is eligible because it will be expensive for you to provide benefits for them if you would like to provide benefits for yourself. So, you see a lot of employers utilize the solo 401(k) for the higher deferral limits, the fact that they can put 100% of compensation away if they need to or up to 100% of compensation away, and if they ever bring on employees, there’s flexibility there as well.
[00:07:10] Andrew: Okay. So, before we jump into the SEP so let’s walk through then on that solo 401(k). So, let’s give an example for the listeners out there. So, let’s say you started a business and started to earn revenue and actually have some profit so your CPA tells you, “Okay. We want you to take a reasonable salary.” So, let’s say that salary, Brian, was if we’re showing total revenue and a net income of maybe 180,000, what would you say reasonable salary? I know it depends on the industry, but you see somewhere between maybe 50,000 and 75,000 would be looked on by the IRS as reasonable?
[00:07:45] Brian: Sure. Maybe they can go higher. It’s also independent on any expenses and any cost of operations they have that they’re going to deduct against their gross income but if we want to say, “Let’s be simplistic. Let’s say they can take 100,000 of that just from your round number of purposes.”
[00:07:59] Andrew: And that’s where we do come in across business owners who maybe don’t have the proper guidance and they are literally showing all in this example, all 180,000 as a distribution. They’re not showing any salary which means the benefit by doing that for them is that they’re not paying into Social Security, Medicare, to FICA and inevitably they’re putting more money in their pocket but that comes with a pretty big risk, correct? Because obviously, if you’re running a business and you’re earning income and you’re not paying into the payroll taxes and you’re just taking it all as distribution at the federal level, can’t we get into some trouble there?
[00:08:36] Brian: You theoretically could and normally I would leave that area up to the CPA in terms of how you would like a client to structure that but, yes, you can get in probably some trouble there in terms of reasonable comp plus I think there are things that you can do if you’re operating at a corporate level which you’re able to utilize your pre-tax dollar more effectively in terms of having certain expenses paid for at the pretax level and giving the advantage of you being able to use the government’s money before it’s taxed.
[00:09:04] Andrew: And then also you’re not paying into social security so down the road even though we don’t know where that will be in 20, 30 years, we do know, I’m going to believe that it will be there in some aspects so if you’re not paying into the system, the system’s not going to pay you back later on. So, we got to be careful there in regard to that reasonable salary. But back to the solo 401(k) example, so if we’re showing 75,000 or in your case, Brian, 100,000 what the solo 401(k) means so that we can kind of get those dollars there is that let’s say an employer who’s the business owner is under 50 so they can put away 18,500 of that right off the top without any issues. They would put that in. And then can they match that to themselves as well?
[00:09:46] Brian: I believe they can put a matching contribution in as well and then they can also use the profit sharing plan components. So, in theory, they could probably get another 55,000 plus on top of their 18,500 into their pension plan for that year and take a deduction for that as well. Many times, what we’re seeing is that after the CPA is done working on the income flow into the business, what the expenses are, they have a specific deduction in mind for the client. They may say, “Look, we want to defer the 18,500,” and they put another 40,000 in the profit sharing plan. Number one, they may not have the revenue to do more and be that would bring their tax level down to the lowest rate possible. So, sometimes it’s a matter of maxing it out like you just said. In other times it’s trying to pinpoint a certain number that the CPA has in mind to make their tax planning most effective.
[00:10:36] Andrew: And I think you hit on the head there as a growing business. I think that a lot of owners will grapple with, okay, I want to defer this money and think long term, but I also need to plow money back into the business and I just can’t do both of them. So, that’s where it’s important as the business starts growing, it’s important to have proactive tax planning sessions with your CPA and most importantly with your financial advisory team. I think over the years I’ve seen it first hand and I know you have as well is that most CPAs are more reactive than proactive. They wait until the end of the year or they wait until February or March just try to start planning for the previous year and it’s impossible to be effective in that case. You find that to be also true when we work with business owners a lot of time?
[00:11:22] Brian: Andrew, that’s 100% true and let me just give you an example of what you just brought up because I think that is an extremely important point to note. So, if you’re using somebody that’s reactive and let’s say the owner’s fiscal year end is 12-31-2017 and we’re sitting there in January, sitting down with the CPA or maybe one of their other advisors and we find that a solo K is the proper tool to utilize for them at 2017. Well, we’re already past the end of 2017 and we’ve lost the ability to defer the 18,500 that needed to be done before the close of the year. The profit sharing plan contribution we could make into 2018 as long as we make it before they file their corporate return, and have it count backward 2017. So, being proactive, addressing this towards the end of the year when we still have the ability to do the deferral would have been paramount but what sometimes and you know this as well as I do we’re sitting with clients and it’s too late to do certain planning. We can only look forward, sometimes we can’t look backward, and we’ve lost valuable time and maybe resources that they’re going to have to give away.
[00:12:31] Andrew: Okay. Perfect. So, it sounds like the solo 401(k) if done in the right timeline it seems pretty simple. You maybe don’t need to get a TPA firm to file with 5,500. I mean these are all things we can kind of get into the weeds and I think you and I can nerd out on it, but we don’t want to bore the listeners. So, easy plan, very effective if you are growing the business and then I guess the only area you have to be careful if you start bringing on employees is the profit sharing side of it of how much you’d have to pay out to these employees if you’re trying to max out yourself?
[00:13:05] Brian: Sure. That’s going to look at certain types of criteria that’s set up for the plan eligibility. Are they eligible based on their service with the company? So, they may not be immediately eligible. Let’s say if he’s had one year of service as their determining eligibility and once they come into the plan, then you may have to decide is it beneficial for me to make a profit sharing plan contribution because they’re going to receive part of it or multiple employees may receive part of it if they’re eligible? So, sometimes we see clients then revert back to a traditional 401(k) with a match and then they decide each and every year whether they’re going to do a profit sharing plan contribution or not.
[00:13:42] Andrew: Okay. And then we’ll just think of it as why we want to put money away? As you said earlier, it’s getting more hard-earned money back in your pocket. If you’re at a 20%, let’s say the 24% bracket or let’s bump that up now to the 32, anything that you defer, if you’re putting away $20,000 it’s in a sense saving you $6,000. So, think of it, listeners, as you put away $20,000 and it’s really only costing you $14,000 so there’s some true and value into that especially as it starts compounding and compounding. So, don’t look at just the business as your asset but try to disseminate some of that and some of that risk because the business itself may be doing well today but it may not do as great in three years so you want to make sure that you’re looking at that and obviously more money in your pocket is going to be better for the long haul. So, solo 401(k) pretty easy. The other thing you mentioned earlier, the other type of planning which I think is even easier is the SEP IRA, the simplified employee pension plan. Walk us through what that looks like.
[00:14:43] Brian: That’s a very simple plan to set up. There’s really no administration whatsoever and then you can utilize that to also put away I believe up to 55,000 for 2018 in terms of a contribution for yourself. You are limited to 25% of your compensation however in doing that. So, you really need to look specifically at your numbers to make sure that based on your compensation you can put away what you would like to put away. So, for example, to be very simplistic, let’s use the business owner that’s making the $100,000. If you’re limited to 25% of compensation, the most that business owner can put away is going to be 25,000 of their 100,000. If they had the desire to put away more, they might be limited there. So, sometimes that percentage of compensation that you can contribute can be a constraining factor in a SEP, sometimes it’s isn’t. The other thing with a SEP is that you do want to be careful that if there are employees you’re going to have and hire that you probably don’t want to use that SEP in that given year as it will be expensive. You must include them, and you must include them at the same percentage of pays you’re putting away for yourself. So, that can be a point where you sit down with a tax advisor or an advisor like us and say, “Does it make sense to keep this in for this given year now that you have one employer more in the business?”
[00:16:03] Andrew: And so, back when you look at the solo 401(k) you had mentioned you can set up some plan criteria or in any 401(k) if the employee has sort of X amount of hours or be there X amount of months or even years before they qualify for the plan but you’re saying with the SEP IRA there is no formula that you can put in there. Once an employee becomes an employee, if you’re putting away 25% for yourself you have to do the same for them?
[00:16:27] Brian: Correct. And so, you’re going to have in a situation where it can get quite expensive. Although it’s very common for people to put that in when they’re first starting out. It’s just them. There’s one person. It’s very easy to set up. There’s no administrative cost although a 401(k), solo 401(k) is easy too and they can just keep putting it away. And then once they realize they’re going to have to hire an employee or additional employees, they can literally stop using that, maybe shift to gears to another plan.
[00:16:51] Andrew: And here’s a great idea. When you look at a lot of a listeners out there, a lot of people we come across, they work in a corporate world. They’ve got a job. They’re a W2 but that term, side hustle, they’ve got a business or they’re consultant to doing contract work, and let’s say that they’re making on the side with this business, 50,000. So, you got somebody’s who’s a W2 employee. They’re making 150,000 working for the company. So, make sure that the listener understands this that they can put into the 401(k) plan to the company. They can max that out. Let’s say it’s 18,500. Maybe get the matching hopefully but then if they’re showing 1099 income reporting it as a separate entity in this case if again they’re making $50,000, would they be allowed to also add money to the SEP account up to that 25% of the 50?
[00:17:37] Brian: That’s a great question and that leads into a great planning tool and the answer is yes, in the right structure. So, for example, let’s say you have an executive at Intel who’s working at Intel and does consulting or has outside revenue that is not related to their employment services at Intel and they’re able to run that as 1099 income or have an LLC set up. They’re certainly not an owner of Intel, a majority owner. They can participate with a 401(k) and other benefit plans that Intel has there and then they can set up on their own to offset some of that consulting or other revenue that they’re bringing in type of pension plan to be able to put money away on a tax saver basis and help them save for retirement in that other entity and we see that as very common, happens across multiple industries. You could have a physician that works for a hospital but does consulting or maybe does expert testimony witness or other forms of employment on the side. Multiple industries have that. So, as long as they’re not an owner of their main company, they could absolutely participate in two different pension plans.
[00:18:39] Andrew: I know, again, we’re not state planning attorneys or on the legal side, but we normally see when they’re running that separate business that the attorney encourages to set up an LLC to incorporate and also to help out on that tax side?
[00:18:53] Brian: That is very common and, again, with some of the tax law changes coming up and some of the effect that those changes have on how income comes through and then it is treated on those different entities, we might see a shift from LLCs to different entities in the future where it’s going to be interesting to see how that shakes out. Again, I’ll probably leave that more to the legal and accounting community but, yes, in most cases, an LLC is the most common. It’s the easiest one to set up and it’s very easy to operate and there are some advantages to being able to run your revenue from that other activity through there, be able to do some great planning for you at the retirement and tax level, and then whatever is left will flow through your personal level.
[00:19:33] Andrew: Okay. And then one of the areas too again with an LLC is besides the tax planning, some of the asset protection that’s involved there, protecting that business asset from the rest of your personal assets so there’s an estate planning aspect to that as well and that’s again where you don’t just want to wait until the 23rd hour to do this planning or to look back and say, “Wow. I wish I would’ve done this planning and now I’m dealing with this potential legal issue and it’s tying in all my assets together.” So, again, be careful. Be cautious out there. Make sure that you’re working with a trusted team that’s looking high level and we call it building the fiscal house, building the Bayntree retirement roadmap, and that’s key to bringing it all together.
Many times, Brian, we see this the advisor or sometimes we call it a broker that really just focus on trying to manage your assets and invest it but they’re not looking at how can we defer some of your income. How can we create some asset protection? How come we look at – are you covered in the what ifs on the insurance side if there’s a disability? So, if you’re not working with somebody that’s taking the high-level approach, I think it’s time for you to go out there and talk to somebody, maybe get a referral from a friend but talk to somebody who’s a fiduciary, who’s building that plan. So, I regress. So, we’ve talked about solo 401(k). We talked about the SEP IRA. What are some of the other things that business owners can do to defer some of their money into a tax-deferred retirement plan?
[00:21:01] Brian: Sure. That’s a great question. Normally, we look at qualified plans which are any type of pension plan as a pyramid. So, a solo 401(k) would be on the bottom part of that pyramid as would be a traditional 401(k). As you know, we help business owners service and help them administer, gosh, multiple plans for thousands of employees with tens of millions of dollars in the investment platforms for the employees. So, we love that as a tool. It’s a wonderful tool for recruitment of employees, for retention of employees and, as you know, in today’s day and age, most employees expect if they’re going to be hired that there’s going to be some plan like that they can utilize to help save for retirement.
Plus, employers usually put in some type of a match that if the employee is going to save, the employer will help them save on their own and there’s a way sometimes to tie that match into what we call golden handcuffs. But that is what we call the base of the pyramid because even though they’re wonderful plans, you might be limited on putting away 18,500 of your own dollars or if you’re over age 50 at the 24,500 level plus an employer match. So, for many employees and some employers, it’s a great tool but for employers that are looking to put away more money, they have a higher tax bill and they need to save more for retirement because they either want to have a certain amount of income at retirement or they’ve started late, it’s limiting. So, as you start to move up that pyramid, you can look at different plans as well.
[00:22:27] Andrew: Before we start moving up the pyramid, back to the simplified the 401(k) plan that most of us know, what we’re seeing a lot more of and now with the Tax Cuts and Jobs Act where the tax brackets have gone down, the standard deduction has gone up, most companies now and we at Bayntree we offer this for our team is they’ve added the Roth 401(k) aspect to the contribution amount and we look at that as a very, very significant way to maybe put money in an account that’s going to grow tax deferred and it’s going to be tax free later. So, Brian, talk a little bit about that of where we’re seeing the Roth 401(k) and where that is primarily a benefit or somebody maybe who’s in a higher income who doesn’t have a chance to put into a Roth IRA where having some of their contributions going to a Roth if their company allows it.
[00:23:21] Brian: Sure. We love that tool and you’re seeing more and more certainly smaller privately-held employers add that tool. Some of the larger companies they went slower to that add that account to the 401(k) plans that they have. So, but if you have a plan like that, it’s a wonderful tool so basically you could decide how to allocate your contributions into either the traditional 401(k) side or the Roth 401(k) side and as I explain employees and I’ve got a large group I’m talking to today is it comes down to tax. Do I want to pay taxes today and have tax-free income later or am I looking for a tax deduction today and I’m willing to pay taxes later? Or do I want to do a combination thereof?
So, many employees when we’re done explaining the benefits of a Roth component or the traditional component, the natural question we get is, “Which one is right for me?” And what we always tell them is there’s no cookie-cutter answer. It depends on everybody’s planning situation like you alluded to, Andrew. And for some people, I get younger people, the Roth may have more benefit because they have more time for the moneys to compound but you might have two working spouses. One spouse can only contribute to a traditional because that’s all their plan offers, and the other spouse has the ability to contribute to either. So, maybe then you do all the Roth for that either spouse. So, everybody’s planning situation is going to dictate which one they might utilize but the fact is if the plan offers it, it’s a wonderful tool and we do advocate our clients who we service their plans to look at adding that tool if they don’t already add it.
[00:24:57] Andrew: Yeah. And that’s a great point. At Bayntree, we service over 14 retirement plans with over 2,000 employees and one thing that we’re seeing a lot more of is those that are maybe just starting to get their foot in the door and just starting to earn some income, maybe in the first, second, third year, and they’re not making as much as they are as maybe in their 20th year. So, when you think about putting money in a tax deferred account and for those people they’re probably not even getting a great tax deduction when they’re putting that money in but the issue is and we’ve seen this firsthand with our clients that are getting close to retirement is that they’ve built up a million, $2 million in pretax along the way and now it becomes a ticking tax time bomb when they have to start taking that money out in retirement whether they need it or their mandatory distribution requires it at 70.5. So, for those that are not earning high income right now, the Roth 401(k) option is almost a no-brainer and then for those that earning good income for me, for example, I do put away half of my 18,500 into the Roth portion.
So, as, Brian, you alluded to, it’s a little bit of a pain today. I’m not getting the tax deduction on that portion but I’m also now setting myself up for an account that in the future is going to be tax free and at some point when I have to start pulling out of my IRA or pretax money, because of the mandatory distributions on the Roth side at least to this point and who knows what good old Uncle Sam will do but there is no requirement to pull out of my Roth IRA and ultimately that is a very good benefit for the long-term. So, with that being said, if you’ve got a Roth option in your 401(k), definitely take a look at it. If your company doesn’t offer it yet, you know what you need to do? Go talk to HR and say, “Hey, why are we not offering this? 90% of companies are,” and, Brian, as you know being in this field working with 401(k), sometimes it just means you have to ask and then they can change the planning rule for the following year.
[00:27:01] Brian: That’s a great point and if you have a company that has many employees let’s say hundreds of employees, the more people that are asking, the better. Obviously, if one person out of 200 is asking their reasons for change, they may not be so motivated to do that but if you are more and more people asking and they realize that it’s a valuable benefit to the offer of their employees and their employees will be happier by having it, they will certainly look to offer it and it’s very easy to do if they want to.
[00:27:27] Andrew: Perfect. So, as we move up this pyramid, walk us through the next area on how we can maybe defer more some of the creative things that we’ve done for a lot of our clients that are business owners that are earning good income.
[00:27:39] Brian: Sure, and we mentioned it a little bit before when we were talking about the solo 401(k) plan. So, the next and I call it the middle layer of this pyramid or what we call profit sharing plans. And a 401(k) is really part of a profit sharing plan but a profit sharing plan, in general, is going to let you put away more money into a qualified plan up to the 55,000 limit for 2018. So, for an employer that let’s just say purely looking for a bigger tax deduction to save for retirement, they might look at utilizing the profit sharing component of their 401(k) to save. Now, if they have employees, depending on how that profit sharing plan formula is allocating money, when they make a contribution they are probably going to have to give some benefit to those employees. So, they can use it as also as a golden handcuff, recruitment, retention tool to reward employees and say, “If we’d had a good year I’m willing to money away in a pool for everybody. It’s going to reward me as the owner,” but you’ll also have a benefit as well. So, they can use that a little bit as what we call the carrot to help motivate employees throughout the year and also increase their own contributions to their own plan.
[00:28:51] Andrew: Perfect. And then we do a lot of these defined pension plans so what does that look like?
[00:28:57] Brian: Before we jump into there, let me say one more big benefit of profit sharing plans because it’s going to be important when we start talking about what we call defined benefit pension plans which is the top of the pyramid. Profit sharing plans are wonderful because you decide each year whether you want to make a contribution or not. So, if there’s a year where revenue is down, production is down, whatever reason, you can say, “I don’t want to make a contribution this year,” and you do not have to. It’s simply a switch that you would use each and every year. So, we always say a client is not locked into making it profit sharing plan contribution which they like because sometimes business dictates that they will not make a contribution so that’s one big advantage of a profit-sharing plan. When you get to the defined benefit pension plan level which is the top of what we call the pyramid where you can put the most money away, you’re usually required to put some contribution in each year, so we can talk a little bit about that as well.
But, Andrew, the nice thing about defined benefit pension plans is for an owner let’s say that’s age 50 and maybe making a nice salary, $220,000 a year, they could put well over $200,000 into a defined benefit pension plan but there’s a couple of things trying to remember with that. Number one, they may have to make some contribution each year. So, if there’s a year where they say any business is off, I want to make a zero contribution. They may not be able to, so you need to have a business owner that’s somewhat comfortable with their revenue stream. They may not have to make $200,000 as a contribution but they might be only able to contribute or turn it down to 40 or 50. So, for a business owner that’s looking at using that plan because they need big tax deductions and they want to save aggressively for retirement they need to understand that they can’t flip that switch like a profit sharing plan as simply as saying, “I don’t want to make a contribution.”
[00:30:44] Andrew: And so, you’re leading into a couple of points there which is that flexibility and with business owners I think the key is, “Can I have a plan that is flexible?” and so that’s where the defined benefits plan where we’ve used it a lot, really you want to look at this is maybe a more mature business or if you’re in professional services, we have a lot of doctors, OB/GYNs that are running their own practice, they have that consistent income coming year-after-year. So, would you say that that is one of the bigger criteria that we would look for if we’re trying to position and defer the max amount which of course the defined pension plan will allow?
[00:31:24] Brian: Sure. And I’m going to be somewhat simple and I’m going to be very general because, obviously, each situation it depends on their own facts and circumstances, but I’ll give you a couple of examples. If you have two owners of a manufacturing company that has 200 employees, you’re probably never going to look at a defined benefit pension plan. Although the owners would love it, because they say, “Hey, between the two of us, we can put $400,000 to $500,000 away,” you’re going to have to include so many of those employees as long as their W2 and not 1099 employees in the company that the contribution for those employees would be so large that they’d say, “Yeah. We can put away a lot for ourselves, but we are not making a contribution for that big a pool of employees.” So, you would never see, or I would say 99% of the time, a defined benefit pension plan in a situation like that. Now, let’s go to the example you use where you might have a physician or a professional that has 20 employees or less. That would be a case where we might use a defined benefit pension plan in combination with a 401(k) so the owners can make significant contributions. They could make contributions to their employees but in a much smaller amount so that every dollar that goes in a plan perhaps $0.80, $0.85 or more goes into the owner or the employees’ pockets.
[00:32:40] Andrew: Okay. When you look at that, I assume that’s going to take a little bit more initial planning and it’s going to have some cost associated with it. We’re probably going to need to bring in what’s called a third-party administrator when creating that?
[00:32:54] Brian: Absolutely. And that’s why it’s so important to have the team working for that client. You’re going to need their CPA involved. You’re going to have to be involved as a planner. You’re probably going to need a very good third-party administrator that knows how to operate plans like that because you will need a pension plan document. You will need to file tax returns for the pension plans each year and most CPAs won’t do that. Those are called 5500s. So, there is a cost element to setting up plans like that. Now, that cost is deductible. It actually needs some tax credits built in the code to help offset that because the government wants small businesses to be able to set up these plans.
Otherwise, the onus will fall to the government when they get to retirement to provide for people with Social Security and Medicare. So, they want people to set this up. But I always say, “Look, if you’re going to spend a certain amount of the pension plan, hopefully, you’re getting a much better return on your investment by the amount of tax savings in terms of your contributions into the plan as well as what you’re billing for retirement.” So, I always say, you’re putting a dollar into a plan. The owners most likely want to get, A, keep $0.80 to $0.85 or more of every dollar or the economics won’t make sense and, B, they want to make sure that the expenses of running the plan are not going to be so great that they’re going to offset the benefits they have of making contributions.
[00:34:12] Andrew: Great points there. And then the other aspect is not feeling pressured that they’re going to have to fund this thing every year and that’s where a lot of business owners will have that trepidation. So, looking at some of the lower down that pyramid makes sometimes more sense especially as we’re getting the business up and running until it becomes more mature but then the issue as it becomes more mature, you have more employees and then you lose out on some of the higher-level things that we’ve just talked about. So, it’s this fine line there depending upon how the business is going to grow and I know for the listeners because this is what Brian and I live and breathe. I know we’ve gone through a lot today. We’ve hit on a lot of different points but one take away is this, is if you’re not having these conversations with your team, CPAs or a state planning attorney, your financial advisor, your team that’s trusted that guide you, you need to start having those conversations key and be proactive in that planning.
I think, Brian, we’re going to probably try to do once a month jump on, talk about different topics like this that are going to be more ingrained in helping the business owner defer money and we know next show we could talk about or what are some of the ways in which you should be investing a defined pension plan. Those type of things that we have on a day-to-day basis with these conversations with our clients. So, as we leave today, the one area is for you as business owners, be diligent and focus on putting as much money as you can away but really focus on having a game plan. And, Brian, with that, I think when you see it, it’s more times than not, they’re just not getting the proper advice. And it’s not your fault, business owner. It’s just that a lot of times it’s not looked on or nobody’s talking to one another.
[00:35:55] Brian: Sure. And I think you and I think very much the same whereas it’s not a matter of saying which plan is perfect for you and a lot of eyes will come and say, “I’ve got the perfect plan for you.” It’s coming from the top and doing your planning from the top down. What are your goals? What are you trying to achieve? And then working backward with the options you have available to find the right tool to fit those goals. That’s how the planning really needs to be done.
[00:36:19] Andrew: Yep. As we do say that nothing’s perfect. No planning side is perfect, no investment is perfect, but if it fits and we build a plan and put those pieces together, it can be the right thing for you as the business owner, as the listener, and what your story is and situation is definitely different than the next person. So, it’s not cookie-cutter. It needs to be customized and then overall that’s going to help you reach your long-term goals of growing the business but the also having a retirement or having a diversification strategy that isn’t tied to 100% of the business. So, hopefully, listeners, today was very intuitive of learning on some of the things that we do and some of the things that you should be doing on the tax planning side. Brian, it’s been great. Really looking forward to our next time on the Your Wealth & Beyond Podcast. Have a great day, and thanks again, Brian, for helping us out here.
[00:37:13] Brian: Oh, my pleasure. Thanks for having me, Andrew.
[00:37:15] Andrew: All right. Talk to you soon. And tune in later this month for more episodes of Your Wealth & Beyond. Andrew Rafal signing off. Thanks so much, everybody.
Thank you for joining me for today’s episode of Your Wealth & Beyond. To get access to all the resources mentioned during today’s podcast, please visit Bayntree.com/Podcast, and be sure to tune in later this month for another episode of Your Wealth & Beyond.
Investment advice is offered through Bayntree Wealth Advisors, LLC, a registered investment advisor. Insurance and annuity products are offered separately through Bayntree Planning Group, LLC. Bayntree is not permitted to offer and no statement made during the show shall constitute legal or tax advice. You should talk to a qualified professional before making any decisions about your personal situation.