Understanding Pension Plans

Your Quick and easy understanding of different kind of retirement plans like defined contribution and defined benefit pension plans.

Pension plans are a big income tax deduction tool. Many successful CPAs, tax planners and financial planners have used pension plans to ensure the biggest income tax deductions for their wealthy clients. Pension plans are also called a rich man’s luxury, because they provide deductions of around a quarter million dollars. Pension plans were officially created by Congress as an income tax planning tool for high earning, self employed physicians, professionals and business owners.

Before we start a detailed understanding of pension plans, though, let’s first understand what retirement plans are. There are two kinds of retirement plans – qualified and non-qualified. Qualified retirement plans are IRS approved, and you can take income tax deductions off of your contributions to your plan. Profit sharing plans, SEP plans and defined benefit plan or pension plan all count as qualified. Non-qualified retirement plans would include a deferred compensation plan, your taxable brokerage or savings accounts. You would not be able to make income tax deductions of your contributions to these kinds of accounts or plans.

In terms of qualified retirement planning options, there are two primary plans – defined contribution plans, and defined benefit plans. Defined contribution plans include profit sharing, SEP and 401k retirement plans.

Understanding Defined Contribution Plans

As the name suggest, in this plan, you define the contribution you make. For example, you would contribute lesser of $49,000 or 100% (25% for SEP) of participant’s compensation to your defined contribution plan. For example, a business owner makes $100,000 in W2 income from his or her business. That business owner could contribute lower of $49,000, or 25% of compensation (here it is $100,000). Since that amount would total $25,000, he or she would contribute the lower amount to their defined contribution plan like SEP.

Learn About Defined Benefit Pension Plans

In a defined benefit plan, a person does not define the contribution made to the plan, but rather, the amount of the retirement benefit at the retirement age. Based on your current age and income in relation to your intended age of retirement, you must establish how much to contribute annually to the defined benefit plan to ensure adequate benefits after retirement. Let’s use the example mentioned earlier. He or she may receive retirement benefit lesser of $195,000 or 100% of average compensation for the highest three consecutive years according to IRS 2011 numbers from their defined benefit plan. To achieve that benefit at retirement how much should the business owner contribute to the defined benefit pension plan (at given rate of return on the contribution investment) now?

These calculations can easily become very complex, and are usually performed by qualified pension attorneys and actuaries. Essentially the biggest bonus to a defined benefit plan is that it will give you a significantly larger deduction, up to $250,000, as compared to the maximum of $49,000 (for year 2011) or $50,000 (for year 2012) deduction from a defined contribution plan.

There are two different kinds of defined benefit pension plans. The first is called a tradition defined benefit plan, and the other is called a fully insured defined benefit plan. The latter is also known as a 412i plan. With the fully insured 412i defined benefit plans, an actuary can take a lower assumed guaranteed interest rate on your contribution to plan, resulting in more income tax deductions for you.

Pension plans are a great income tax and retirement planning tool, but they require special expertise to get the maximum benefits possible, as there are many IRS rules to be followed in regards setting up the proper plan documents (including and excluding the employee, contribution to the plan, validating a plan and filing the annual 5500 pension tax return to IRS).

At BeamaLife, we deal with many defined benefit pension plans and have best plan designs in the country. To get the biggest deduction possible, whether you are a business owner, doctor, or other hard-working professional, with minimum expenses, call BeamaLife at (877)972-3262 or complete our short retirement and pension plans information form now.