Professional Benefit Plans: Misconceptions and Common Concerns

Posted on October 3, 2011 by Bill Faiferlick

“I’ve got 401(k), investments, and other plans in place. Don’t I have my retirement handled quite well?”

If you can live on whatever accumulated values your 401(k) program may provide after market fluctuations, and you do not need larger tax deductions, then OBP plans are not suitable for your needs. If not, then an OBP could make a dramatic difference.

“How do I know that this investment is legal, safe, and secure?”

All qualified benefit plans, whether they benefit business employees or owners, are governed by the ERISA codes monitored by the U.S. Government, Department of Labor, and Internal Revenue Service.

“I’ve read that only small businesses benefit from these plans.”

This is misinformation. Large companies can benefit from OBP’s. Using a complex plan, OBPs can be designed and implemented for businesses of all sizes, including those with over a thousand employees.

“I can do better investing after-tax dollars because I’m still going to pay taxes anyway!”

Let’s use the illustrations below to examine this idea.

Investing After-Tax Dollars

Contribution:                                                       $180,000

Retirement Income:                                             $120,000

Tax Rate – pre-retirement:                                          40%

Tax Rate – post-retirement:                                         40%

Investment Return:                                                      10%

Investing After-Tax Dollars
Year Age Cash Contribution Taxes Fund Value Before-Tax Yield Pre-Tax Return Post-Return Tax After-Tax Yield Retirement Income
2004 53 180,000 72,000 108,000 10,800 4,320 - 6,480 -
2005 54 180,000 72,000 222,480 22,248 8,899 - 13,349 -
2006 55 180,000 72,000 334,829 34,383 13,753 - 20,630 -
2007 56 180,000 72,000 472,459 47,246 18,898 - 28,348 -
2008 57 180,000 72,000 608,806 60,881 24,352 - 36,528 -
2009 58 180,000 72,000 753,334 75,333 30,133 - 45,200 -
2010 59 180,000 72,000 906,534 90,653 36,262 - 54,392 -
2011 60 180,000 72,000 1,068,927 106,893 42,757 - 64,136 -
2012 61 180,000 72,000 1,241,062 124,106 49,642 - 74,464 -
2013 62 - - 1,315,526 119,553 - 47,821 71,732 120,000
2014 63 - - 1,267,257 114,726 - 45,890 68,835 120,000
2015 64 - - 1,216,093 109,609 - 43,844 65,766 120,000
2016 65 - - 1,161,858 104,186 - 41,674 62,512 120,000
2017 66 - - 1,104,370 98,437 - 39,375 59,062 120,000
2018 67 - - 1,043,432 92,343 - 36,937 55,406 120,000
2019 68 - - 978,838 85,884 - 34,354 51,530 120,000
2020 69 - - 910,368 79,037 - 31,615 47,422 120,000
2021 70 - - 837,790 71,779 - 28,712 43,067 120,000
2022 71 - - 760,858 64,086 - 25,634 38,451 120,000
2023 72 - - 679,309 59,931 - 22,372 33,559 120,000
2024 73 - - 592,868 47,287 - 18,915 28,372 120,000
2025 74 - - 501,240 38,124 - 15,250 22,874 120,000
2026 75 - - 404,114 28,411 - 11,365 17,047 120,000
2027 76 - - 301,161 18,116 - 7,246 10,870 120,000
2028 77 - - 192,031 7,203 - 2,881 4,322 120,000
2029 78 - - 76,353 0 - 0 0 76,353
2030 79 - - 0 0 - 0 0 0

Investing Pre-Tax Dollars

Contribution:                                                      $180,000

Retirement Income:                                            $120,000

Investment Return (age 53-61):                                5.00%

Investment Return (age 62-88):                              10.00%

 

Investing Pre-Tax Dollars
Year Age Cash Contribution Taxes Fund Value Before-Tax Yield Taxes After-Tax Yield Income Taxes Retirement Income
2004 53 180,000 0 180,000 9,000 0 9,000 - - -
2005 54 180,000 0 369,000 18,450 0 18,450 - - -
2006 55 180,000 0 567,450 28,373 0 28,373 - - -
2007 56 180,000 0 775,823 38,791 0 38,791 - - -
2008 57 180,000 0 994,614 49,731 0 49,731 - - -
2009 58 180,000 0 1,224,344 61,217 0 61,217 - - -
2010 59 180,000 0 1,465,562 73,278 0 73,278 - - -
2011 60 180,000 0 1,718,840 85,942 0 85,942 - - -
2012 61 180,000 0 1,984,782 99,239 0 99,239 - - -
2013 62 - - 2,084,021 94,201 0 94,201 200,000 80,000 120,000
2014 63 - - 1,984,782 177,822 0 177,822 200,000 80,000 120,000
2015 64 - - 1,956,044 175,604 0 175,604 200,000 80,000 120,000
2016 65 - - 1,932,648 173,165 0 173,165 200,000 80,000 120,000
2017 66 - - 1,904,813 170,481 0 170,481 200,000 80,000 120,000
2018 67 - - 1,875,294 167,529 0 167,529 200,000 80,000 120,000
2019 68 - - 1,842,824 164,282 0 164,282 200,000 80,000 120,000
2020 69 - - 1,807,806 160,711 0 160,711 200,000 80,000 120,000
2021 70 - - 1,767,817 156,782 0 156,782 200,000 80,000 120,000
2022 71 - - 1,724,598 152,460 0 152,460 200,000 80,000 120,000
2023 72 - - 1,677,058 147,706 0 147,706 200,000 80,000 120,000
2024 72 - - 1,624,764 142,476 0 142,476 200,000 80,000 120,000
2025 74 - - 1,567,241 136,724 0 136,724 200,000 80,000 120,000
2026 75 - - 1,503,965 130,396 0 130,396 200,000 80,000 120,000
2027 76 - - 1,434,361 123,436 0 123,436 200,000 80,000 120,000
2028 77 - - 1,357,797 115,780 0 115,780 200,000 80,000 120,000
2029 78 - - 1,273,577 107,358 0 107,358 200,000 80,000 120,000
2030 79 - - 1,180,935 98,093 0 98,093 200,000 80,000 120,000
2031 80 - - 1,079,028 87,903 0 87,903 200,000 80,000 120,000
2032 81 - - 966,931 76,693 0 76,693 200,000 80,000 120,000
2033 82 - - 843,624 64,362 0 64,362 200,000 80,000 120,000
2034 83 - - 707,986 50,799 0 50,799 200,000 80,000 120,000
2035 84 - - 558,785 35,879 0 35,879 200,000 80,000 120,000
2036 85 - - 394,664 19,466 0 19,466 200,000 80,000 120,000
2037 86 - - 214,130 1,413 0 1,413 200,000 80,000 120,000
2038 87 - - 15,543 0 0 0 15,543 6,217 9,326
2039 88 - - 0 0 0 0 0 0

 

In this illustration, pre-tax investing provides an income for 26 years, compared with a 17-year income with after-tax investing. Clearly, anyone would be financially ahead with pre-tax investing. The advantage lies in the compounding interest on the dollars you are not paying in taxes each year.

“I’ve got my retirement handled. After all, when I sell my practice, I’ll have plenty to retire on!”

This is a common misconception of business owners and professionals. They count on the sale of their business for their retirement income, but over-estimate the value of their business. Often, the perceived value is not realized at the time of sale, and an owner receives much less than 100% of the value of business.

Also, the sale of a business can be affected by many economic factors (interest rates, availability of borrowing funds, etc.), which may be unfavorable at the time that the owner needs to sell. Often, competitors do not want to buy out the owner. They may believe that, since the professional is retiring, that competition will disappear anyway. Frequently, an owner is an integral part in the value of a business. When he retires, this marketable part of business and knowledge goes with them. Another common problem is that the owner may not find a purchaser. If a buyer is found, owners may need to the sell business on an installment basis. There is no guarantee that the business will last to make the required payments.

For the professional, it makes more sense to make the practice work for retirement advantages while it is still a viable, working entity, by taking a portion of what is normally paid in taxes and placing it in a Professional Benefit Plan. This guarantees a retirement income, and when he or she sells the business, he or she may be able to defer a portion of the taxable gain, also.

“A Professional Benefit Plan would cost the practice too much money, because most of the increased benefits will go to the employees.”

Usually, this is not the case. A worse case example would be that, after a preliminary inquiry, a Professional Benefit Plan does not make good economic sense for a particular practice. The plan is not adopted, no costs are incurred, and no harm is done. On the other hand, by not making an inquiry, it’s likely that the cost to a professional owner is larger contributions to the federal government, and less to his or her personal retirement!

“I’ll call my CPA. He’ll know if this is an opportunity for me.”

This is probably the biggest misconception a professional has. CPA’s are often not familiar with Professional Benefit Plans and ERISA requirements.