Business Succession Planning for Business Owners

In a defined benefit plan, an actuary calculates the amount of your annual deductible contribution. The magnitude of the deduction is a function of the benefits provided.¹ The deductible contribution must be consistent with the limitations of law and sufficient to fund the benefits promised to you by the plan. At retirement age, the maximum monthly retirement benefit under current law is $17,500 per month. In order to guarantee that retirement benefit is funded by your normal retirement age, you must have a total of $6,909,262 in your retirement fund by the time you retire. We noted above that defined benefit plans may contain life insurance and that the cost of this insurance is in addition to the cost of providing the monthly retirement benefit of the plan. The Benefit Focused Plan fully utilizes this ability, making it an essential part of the overall strategy because: By funding the plan death benefit with life insurance, you are able to increase your contributions to the plan with resulting income tax savings. At plan inception, it will double your contribution with only a third of the increase going to insurance premiums. A Benefit Focused Plan without a death benefit will permit a first year contribution of $325,446. The addition of a pension pre and post-retirement death benefit will require, according to the Pension Protection Act of 2006, a value based on IRS actuarial tables, further increasing plan contributions by as much as two times, but requiring only a third of the increase to guarantee the benefit through life insurance. As shown in the table below, in this case the contribution would increase to $633,459, nearly doubling the contributions.

Meanwhile, this increase in pension contribution of about $300,000 will require only about $100,000 in premiums. While this difference will balance out over time, it causes an early injection of extra cash into investment accounts, builds additional assets in the form of policy cash surrender values and will result in additional tax savings of about $400,000 in the years prior to retirement.

Another feature of the Benefit Focused Plan that is implicit in these benefits is that the assets that are in the plan are safe from creditor claims under both state and federal law. A cash balance plan, on the other hand, cannot offer the same level of protection. The latter can provide creditor protection under state law, but not necessarily under federal law¹. It permits the purchase of life insurance on a before-tax basis, a savings of about 40%. It lowers risk exposure² for the investment policy of the overall plan. That is, having more assets in the plan – which now includes the insurance guaranteed cash value³ – may lower the overall yield on investment that would otherwise be required to provide the same monthly retirement benefits. It provides an indirect estate planning benefit by permanently removing assets from the estate so they will not be subject to estate tax. It provides a direct estate
planning benefit, making
cash available to pay estate
tax on assets that remain in the estate.⁴

1.Section 436 of the Retirement Equity Act of 2006 values the death benefit based on the IRS actuarial tables and Treasury yield discount rates.

² Contributions are not the same throughout the funding period: they are individually determined for each year’s contribution by the actuary in the annual plan valuation.

3 The risk exposure is lowered by lowering the required rate of return on investment. The magnitude of this benefit tends to increase with the age of the participant at the time of plan inception. Worst-case scenarios are with young (age 40) participants where there is no significant difference between investment yield requirements for plans with and without insurance. Even when this variable is minimal, the participants still enjoy higher income tax deductions as well as all the other enumerated benefits of incorporating life insurance into the plan.

4 In contrast to other approaches to the estate tax problem which involve gifting after tax dollars to pay premiums to an irrevocable life insurance trust, the Benefit Focused Plan provides this benefit while conserving all of the “unified gift and estate tax credit equivalency.”

Charlie Day is a co-contributor to this press release.