Maximize Tax Deductions and Retirement Income with a Fully Insured Pension Plan
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For the business owner who would like to maximize tax deductions and secure guaranteed retirement income, the Fully Insured Defined Benefit Pension Plan may be the answer!
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Maximize Tax Deductions and Retirement Income with a Fully Insured Pension Plan
- 1. Copyright 2015, The Ohio National Life Insurance Company Fully Insured PensionFully Insured Pension Plan for BusinessPlan for Business OwnersOwners Maximum Tax Deductions with Guaranteed Retirement Income Presented by: Nick Chaplain The Ohio National Life Insurance Company Ohio National Life Assurance Corporation Ohio National Equities, Inc. Member FINRA
- 2. 2 Copyright 2015, The Ohio National Life Insurance Company The Ohio National Life Insurance Company and Ohio National Life Assurance Corporation issue a variety of life insurance and annuity products. Product availability varies by state. Guarantees are based upon the claims-paying ability of the issuer.
- 3. 3 Copyright 2015, The Ohio National Life Insurance Company Why Business Owners Need Qualified Retirement Plans For maximizing tax benefits For solving liquidity problems that occur at retirement or death For sheltering assets from legal liability and creditors For avoiding taxes on excess accumulated earnings
- 4. 4 Copyright 2015, The Ohio National Life Insurance Company Questions To Consider Is your retirement account underfunded? Do you need to reduce your taxable income significantly? Would you like to provide substantial survivor benefits to your beneficiaries? Have stock market declines hurt your retirement “nest egg”?
- 5. 5 Copyright 2015, The Ohio National Life Insurance Company Qualified Retirement Plans Provide retirement, disability and/or death benefits Must meet specific Internal Revenue Code requirements Qualify for tax-favored treatment Cannot discriminate
- 6. 6 Copyright 2015, The Ohio National Life Insurance Company Qualified Retirement Plans Two main tax advantages for an employer’s contributions 1. Taxable income is REDUCED by the amount contributed 2. Retirement savings in the owner’s account grows TAX DEFERRED
- 7. 7 Copyright 2015, The Ohio National Life Insurance Company Qualified Retirement Plans Two Types of Qualified Plans Defined Contribution Defined Benefit
- 8. 8 Copyright 2015, The Ohio National Life Insurance Company Qualified Retirement Plans Defined contribution: 25% of compensation limit for tax-deductible CONTRIBUTIONS Defined benefit: $210,000 per year maximum BENEFIT * *Under current law – dollar amount indexed and may increase each year
- 9. 9 Copyright 2015, The Ohio National Life Insurance Company Defined Contribution Plans Retirement benefit Participant receives account balance at normal retirement date Annual contribution Usually % of current salary Limit on each participant’s annual contribution Lesser of $53,000* or 100% of salary *Under current law – dollar amount indexed and may increase each year
- 10. 10 Copyright 2015, The Ohio National Life Insurance Company 25 Age 65 Age $400,000 40 yrs Contribution = $10,000/yr 55 Age 65 Age $100,000 10 yrs Contribution = $10,000/yr How Defined Contribution Plans Work
- 11. 11 Copyright 2015, The Ohio National Life Insurance Company Defined Benefit Plans Pension benefit Set by plan formula Annual contribution Amount needed each year to provide pension at normal retirement date Limit on each participant’s annual contribution No dollar limit on annual contribution
- 12. 12 Copyright 2015, The Ohio National Life Insurance Company 25 Age 65 Age $1,000,000 40 yrs Contribution = $25,000/yr 55 Age 65 Age $1,000,000 10 yrs Contribution = $100,000/yr How Defined Benefit Plans Work
- 13. 13 Copyright 2015, The Ohio National Life Insurance Company How a Fully Insured Pension Plan Works Business makes tax-deductible contributions to the fully insured pension plan Fully insured pension plan purchases annuities and insurance policies Retirement distributions made or benefits rolled to another qualified plan
- 14. 14 Copyright 2015, The Ohio National Life Insurance Company How Does a Fully Insured Pension Plan Differ? Plan funding Whole life insurance and fixed annuities or Fixed annuities alone Guaranteed benefits No market risk
- 15. 15 Copyright 2015, The Ohio National Life Insurance Company End Result Larger current tax deductions Guaranteed retirement benefits
- 16. 16 Copyright 2015, The Ohio National Life Insurance Company What’s the Bottom Line? For each dollar you contribute to the fully insured pension plan, the government funds 30 to 40 cents of your retirement through the available tax deduction (depending on applicable tax bracket)
- 17. 17 Copyright 2015, The Ohio National Life Insurance Company Traditional Defined Benefit Plan vs. Fully Insured Defined Benefit Plan Traditional Plan Fully Insured Plan Limited early contributions Larger contributions in early years May become over/underfunded Always fully funded Quarterly contribution deadlines Funding extended to tax filing deadline
- 18. 18 Copyright 2015, The Ohio National Life Insurance Company Life Insurance in a Fully Insured Pension Plan Provides estate liquidity Tax-deductible premiums Insures retirement benefit against premature death
- 19. 19 Copyright 2015, The Ohio National Life Insurance Company Life Insurance in a Fully Insured Pension Plan No reduction in the retirement benefit Lower net cost since purchased with pre-tax dollars Increases the contribution and maximizes tax deduction Provides a source of income for loved ones Economic benefit cost reported to the employee annually to preserve tax-free status of death benefit Life insurance can be continued after retirement
- 20. 20 Copyright 2015, The Ohio National Life Insurance Company *Without regard to the economic benefit cost and tax deduction **Assumes 40% combined federal and state tax bracket Life Insurance in a Fully Insured Pension Plan Cost Effective Life Insurance Cost of $10,000 Premium In Retirement Plan = $10,000 Using pre-tax dollars* Outside Retirement Plan = $16,667 $10,000 premium and $6,667** in income taxes
- 21. 21 Copyright 2015, The Ohio National Life Insurance Company Frequently Asked Questions Do I have to include everyone? Will my contribution level remain constant? Who can benefit from a fully insured pension plan?
- 22. 22 Copyright 2015, The Ohio National Life Insurance Company Do I Have to Include Everyone? May exclude Part-time employees Less than 1000 hours per year Employees less than 21-years old Employees with less than one year of service
- 23. 23 Copyright 2015, The Ohio National Life Insurance Company Do I Have to Include Everyone? Vesting Employee usually must stay a minimum number of years with company to receive full benefits Vested employee cannot lose benefits, even if the employee leaves the job before retiring
- 24. 24 Copyright 2015, The Ohio National Life Insurance Company Will My Contribution Level Remain Constant? Following year’s contributions reduced by Interest in excess of guaranteed rate Dividends
- 25. 25 Copyright 2015, The Ohio National Life Insurance Company Will My Contribution Level Remain Constant? Fully Insured Defined Benefit Pension Plan Traditional Defined Benefit Plan
- 26. 26 Copyright 2015, The Ohio National Life Insurance Company Who Can Benefit From a Fully Insured Pension Plan? Based on three factors Income Age Number of years UNTIL retirement
- 27. 27 Copyright 2015, The Ohio National Life Insurance Company Who Can Benefit From a Fully Insured Pension Plan? Business owners who Are age 50 or older and within 10-15 years of retirement Have few non-owner employees Desire to contribute as much as possible to their retirement on a tax-advantaged basis Prefer conservative investments over more speculative ones
- 28. 28 Copyright 2015, The Ohio National Life Insurance Company Establishing a Plan Established in writing before the end of the fiscal or calendar year for which a tax deduction is desired Annual IRS Form 5500 must be filed TODAY!
- 29. 29 Copyright 2015, The Ohio National Life Insurance Company Supercharge Your Retirement Fully Insured Pension Plans Are ideal for SELECT businesses Provide large tax deductions Can include a cost effective death benefit if needed
- 30. 30 Copyright 2015, The Ohio National Life Insurance Company Conclusion For the business owner who would like to maximize tax deductions and secure guaranteed retirement income, the Fully Insured Defined Benefit Pension Plan may be the answer!
- 31. Fully Insured DefinedFully Insured Defined Benefit Pension PlanBenefit Pension Plan for Business Ownersfor Business Owners Maximum Tax Deductions with Guaranteed Retirement Income
Editor's Notes
- I would like to talk to you about fully insured pension plans – which are sometimes called 412(i) plans.
- Tax-qualified plans can help successful business owners meet a variety of needs: reducing your tax burden, protecting your family’s quality of life by sheltering assets from legal liability and creditors, and helping you prepare for retirement. In addition, for C corporations, the tax deduction for contributions results in reduced accumulated earnings and the exposure to the accumulated earnings tax.
- But before we look into whether or not a fully insured pension plan is right for you, let’s consider the following questions: Is your retirement account underfunded? Would you like to dramatically increase your tax-deductible retirement savings? Would you like to provide substantial survivor benefits to your beneficiaries? Do you need to diversify your retirement portfolio by increasing your “safe money” assets? Wouldn’t you like the assets you will depend on for your retirement security to be safe from market declines? To sum it up, has your need for increased retirement savings intersected with your desire to minimize taxes? If so, a fully insured pension plan may be the answer.
- In order to get a better understanding of fully insured pension plans, it’s important to have a basic understanding of qualified retirement plans. Qualified retirement plans are typically set up by employers to provide their employees with a benefit at retirement, disability or death. These plans are referred to as qualified because, if they meet specific requirements, they qualify for favorable tax treatment under the Internal Revenue Code. This favorable tax treatment includes tax-deductible contributions for employers and self-employed individuals, tax-deferred growth, and the ability to roll over plan benefits into an individual retirement account/annuity after leaving the company. The plan cannot discriminate in favor of highly compensated employees, including the owners of the business. If it does discriminate, it could lose its tax-favored qualification and jeopardize both the employer’s tax deduction and the employee’s income deferral.
- For you the employer, there are two main tax advantages for contributing to a qualified retirement plan. 1. The amount that the employer contributes to the plan is tax deductible (within certain limits) in the year contributions are made. So your taxable income is reduced by the amount contributed. 2. The earnings on the investment of plan assets are tax deferred for the owner and employees alike. Installments or annuity payments are taxed only when received, i.e., distributed. In addition, income taxes on certain distributions may be deferred by rolling over the distribution into an Individual Retirement Account (IRA) or to another qualified retirement plan. Tax advantages also exist for the employee. Current taxable income to the employee is reduced by the employee’s salary deferral contributions. Further the employee does not have to pay income tax on the employer’s contribution to the plan on their behalf, or on earnings to those contributions until benefits are received, with a minor exception for life insurance in the plan, which we’ll discuss in detail later.
- There are two broad categories of qualified retirement plans: defined contribution plans, such as 401(k) and profit sharing plans; and defined benefit plans. Fundamentally, the difference between the two types of retirement plans is that defined benefit plans offer fixed retirement benefits. The amount of the retirement benefit under defined contribution plans fluctuates based on employer and employee contributions and subsequent investment performance of the plan. The plan that we’ll be discussing today -- the fully insured pension plan -- is a special type of defined benefit plan, with a guarantee of retirement benefits.
- Defined contribution plans provide a contribution that is fixed or chosen each year by the employer (plan sponsor), for example: 10 percent (up to a maximum of 25 percent of compensation each year.) This money is contributed to the plan and is tax deductible to the sponsor. The contribution then grows, tax deferred, until retirement benefits are paid. The amount of retirement income is contingent upon the investment rate of return achieved for the dollars contributed. A defined benefit plan works in reverse. Contributions made to fund participant benefits are not limited to a fixed percentage of pay, nor to a fixed-dollar amount (e.g., $53,000 per participant in 2015.) The contribution is determined as the amount required to fund the benefit specified in the plan formula. For example, how much is needed to provide $210,000 per year income for life, starting at age 65? The maximum annual retirement benefit or income is currently $210,000 (indexed for inflation) starting as early as age 62 retirement age (with 10 years of participation.) The nature of the defined benefit plan dictates that the fewer the years until retirement, the larger the required contribution, regardless of the assumed rate of growth. Let me explain it further. Let’s look first at defined contribution plans because you may be more familiar with these plans.
- In a defined contribution plan, you receive an allocation each year that is usually a percentage of your compensation. It is put into your plan account and credited with gain or loss each year, depending on the investment rate of return. There is a limit each year -- known as the annual additions -- as to the amount that can be contributed to a participant’s account. Under current law, it is the lesser of 100% of the participant’s compensation or $53,000. The employer can deduct up to 25% of payroll, plus employee 401(k) salary deferrals. Each participant’s compensation is limited currently to $265,000 for this purpose. At retirement, your retirement benefit is whatever your account balance is. Unfortunately these plans often impose substantial employee cost on the business owner, while sharply limiting the amount the business owner can contribute and deduct for himself.
- These plans tend to favor younger employees. Let’s look at why that is. As you can see on this chart, the younger employee has more years until retirement. Therefore, the younger employee will have received a greater number of contributions than the older employee by retirement and will have a higher account balance at retirement than the older employee. The only way older employees could make up for receiving fewer contributions is if they could get really high contributions each year, but there’s a problem. The maximum allocation to a participant in a defined contribution plan is the lesser of 100% of that participant’s compensation or $53,000 as indexed for inflation -- the limit that we discussed on the previous slide.
- Well – what about a defined benefit plan? It is a traditional type of pension plan that promises to pay employees a specified retirement benefit. “Benefit” is usually defined as a monthly benefit based on compensation and years of service. A plan actuary reviews the plan each year and calculates the amount that is to be contributed so the plan will have sufficient assets to pay the promised benefits to participants at retirement. These plans tend to favor older employees. Let’s see why that is.
- In this example, a younger and an older employee are both entitled to the same benefit at retirement. This benefit will cost the plan a million dollars for each of them. To make this example simple, we are not including any of those actuarial assumptions -- like interest and mortality. Since the older employee has fewer years until retirement, the contributions made for the older employee must be higher if the plan is to accumulate a million dollars for the older employee in the fewer years the older employee has until the older employee’s normal retirement date. $100,000 is a large contribution. You might wonder if the older employee really gets contributions that large in a defined benefit plan. The answer is yes, because there is no dollar limit on the contribution that can be made for each employee in a defined benefit plan.
- Step 1: The business makes tax-deductible contributions to the plan. Step 2: The plan purchases annuities and life insurance policies. Step 3: Retirement distributions can be made or benefits rolled to another retirement vehicle (ex. IRA) or converted to a retirement income stream.
- While traditional defined benefit plans can be funded with a wide range of investment options, a fully insured pension plan must be funded by fixed insurance products with guaranteed values: either retirement annuity contracts alone, or a combination of life insurance and retirement annuities. This plan fully insures the amount of your retirement income benefit. You know in advance what your retirement income will be – guaranteed.
- The end result is larger current tax deductions. The amount needed to fund the benefit is mathematically derived using the guaranteed cash values and annuity purchase rates of insurance products. Traditional defined benefit plans allow for higher interest rate assumptions, which mean you contribute less to the plan. In a fully insured plan, the lower interest rate guarantees mean lower plan assumptions, so your contributions can be higher. Higher contributions mean greater current tax deductions. Plus, as I mentioned plan assets are in guaranteed insurance company products -- no market risk of principal.
- AND, for each dollar you contribute to the fully insured plan, the federal government through the tax deduction funds 30 to 40 cents of your retirement, depending on your particular tax bracket that is.
- To summarize, compared to traditional/uninsured defined benefit plans, a fully insured defined benefit plan allows you to make larger contributions in early plan years. Because of the volatility of the stock market, unpredictable investment returns may cause some traditional plans to become “underfunded” when the market is slumping, or “over-funded” when the market is strong. Fully insured plans offer greater stability than market-invested plans. Business owners can also extend the funding of the fully insured plan to the tax-filing deadline (rather than year-end). So, you could sign the fully insured plan documents by year-end, but not fully fund it until the tax-filing deadline in the following year (including extensions). This flexibility may help you and your business manage cash flow better than with a traditional defined benefit plan, which requires quarterly contributions.
- By including life insurance in the plan, it can assure your estate of needed liquidity on a tax-deductible basis and reduce your cost of providing needed life insurance to your family and business. When a fully insured plan includes life insurance, there is a self-completing element to the plan. If the insured participant dies while in the plan, the death benefit can replace the decedent’s current earnings and offer valuable protection to the family. By including life insurance in the plan, you will have both a death benefit and a retirement benefit. You’ll have the security of knowing that the death benefit under the plan will help protect your family if you die before retirement and before completion of the funding of the plan.
- Importantly, adding an enhanced survivor benefit to the plan does not alter the retirement benefit by one dime. Rather, the marginal cost of the survivor benefit is calculated and is added to the tax-deductible contribution. It guarantees you and your eligible employees a death benefit if you or they die before reaching retirement age. When life insurance is used to fund any of the benefits, a relatively small amount of income must be recognized each year by each participant covered by life insurance. This amount is known as the “economic benefit.” Then at death, the difference between the policy face amount and the cash value is paid out income-tax free. The life insurance portion of your plan can be continued after retirement.
- A $10,000 premium outside of a retirement plan actually costs $16,667 assuming a combined federal and state income tax bracket of 40%. You would have to earn $16,667 to net $10,000 after taxes to pay the $10,000 premium.
- I thought I would cover some of the most frequently asked questions.
- Employers must offer participation in the plan to all eligible employees as defined by length of employment, age and hours worked.
- You can also have a vesting schedule. Most plans use a vesting schedule that requires employees to work for an employer a specified period, such as six years, before they are 100% vested. If a participant’s employment is terminated before the participant is vested, the non-vested portion of the account is forfeited and remains in the plan, which means that a lower contribution will be required to fund the remaining employees’ benefits.
- Your contributions will gradually decrease since the excess interest earned over the guaranteed rate must be used to reduce the following year’s contribution. Any dividend payable on the life insurance policy will also be used to reduce the following year’s contribution. Let’s look at a graphic illustration of the comparison of funding a traditional defined benefit plan vs. the fully insured plan.
- With the fully insured plan the initial contribution is based on the guaranteed interest rates in the life insurance products, and the next year’s contribution is offset (lowered) by the difference between the guaranteed and current rates. That means that the maximum contribution is in the early years (front end loaded, so to speak), and each year thereafter the contribution will decrease. Compare this to a traditional defined benefit plan in which the contribution amount can be highly unstable. Each year there is an actuarial calculation to ensure the accumulation goal is on target. Actuarial assumptions are educated guesses as to such factors as mortality (how long the participants are expected to live), interest rates (the rate at which assets are expected to grow), turnover (how many participants can be expected to leave the plan each year), and salary scale (how salaries might be expected to increase.) So the calculation and hence your contribution could increase or decrease, sometimes significantly, depending on all of these factors.
- The formula used to achieve the benefit in a fully insured plan focuses on age, income, and years to retirement, thus normally favoring the older owners of a business who typically make significantly more money than their employees and have fewer years to build their retirement assets.
- While almost any employer can set up a fully insured plan, this type of plan is often most appealing to business owners who are older, highly compensated, and have few non-owner employees. Generally, business owners who Are age 50 or older and within 10-15 years of retirement. Are highly compensated. Have few (or no) non-owner employees. Want to contribute as much as possible to their retirement on a tax-advantaged basis. Can commit to regular plan contributions. And, importantly, prefer security (guarantees) over the volatility of the stock market.
- One important administrative note to remember is that the plan must be established in writing before year-end, though funding can occur thereafter up until the due date of the tax return, including extensions. In addition, an IRS form 5500 must also be filed annually to be compliant.
- If your overall objective is a large tax deduction, a secure promise of benefits, more stability, and less complexity, the fully insured plan has merit.