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Setting up your own pension

A Gallup poll taken in April 2010 found that 63 percent of Americans expected their taxes to go up within a year’s time.
 Charles Sims Jr.  

by Charles Sims Jr. CFP

A Gallup poll taken in April 2010 found that 63 percent of Americans expected their taxes to go up within a year’s time. Perhaps unsurprisingly, the expectation of higher taxes tended to increase with income: 74 percent of taxpayers with $75,000 or more in household income expected higher taxes within the year.

Business owners may have more options for sheltering income from current taxes than ordinary wage earners. One option is setting up a solo defined-benefit plan. This plan offers self-employed individuals and some business owners a tax-advantaged opportunity to target an annual retirement benefit that is comparable with their pre-retirement incomes.

Like the big guys

A solo defined-benefit (DB) plan is not unlike the pension plans offered by large corporations. The participant chooses a retirement income target and then an actuary calculates the annual contributions that would be required to meet the target. In 2010, the target benefit amount may not exceed the lesser of $195,000 or 100 percent of the participant’s average annual income for the past three years.

Once the plan is in place, the participant is required to make the annual contributions until the plan is fully funded. Contributions are generally tax-deductible, and any earnings accumulate on a tax-deferred basis. It wouldn’t be unusual for a business owner to put $100,000 a year in a solo DB plan.

There are some rules and drawbacks, as well. Although there is some leeway for a participant to secure a temporary waiver of his or her contribution for a plan year if paying the full amount would cause a “substantial business hardship,” failing to meet the funding requirements typically results in an excise tax.

Also, the tax code generally requires a company offering a DB plan to make contributions for all employees. There are exceptions for employees younger than 21 and those who have not worked at least 1,000 hours during any 12-month period. Before you take any specific action, be sure to consult with your tax professional.

As with most other retirement plans, there are fees associated with setting up and maintaining a solo defined-benefit plan. There is an initial plan setup fee and an annual fee for actuarial services, which are required to ensure that the investments are on track to reach the funding requirements.

(Charles Sims Jr., CFP, is President/ CEO of The Sims Financial Group. The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.)

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