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Year-end pension planning for small businesses

The #1 tax shelter for successful self-employed small business owners

by Tony Novak, CPA, MBA, MT    December 2, 2014

Successful self-employed individuals often delay the decision to start a small business pension plan until the month of December. But that does not mean that this is the appropriate time for a lengthy article on the details of pension planning. This article is meant to compile seven fast facts that business owners should consider in December 2014. This article focuses on one person pension plans but may also apply to businesses with a few employees.

1. Pension plans are the #1 most effective tax shelter for high income self-employed individuals this year. The elimination of many other popular tax breaks effective January 1, 2014 made self-employed pension plans more relevant to tax planning than at any other time in recent history.
2. The average total first year tax-deductible contribution for a self-employed individual is $150,000 to $250,000.* The higher deduction amount is achieved by combining the pension with a 401(k) plan. This translates to an immediate tax savings of roughly about $50,000 up to as much as $140,000! We don't suggest starting a pension plan unless you plan to fund more than $75,000 per year since other options are more cost-effective.
3. Costs for setting up and running a pension plan have declined as a percentage of plan assets due to use of technology. This means that pensions are more attractive than in the past. The typical cost is $1,500 to set up a new pension plan and $2,000 per year for the actuarial report and annual filing requirements.
4. Investments in a self-employed person's plan are effectively self-directed. Bland investments like index funds work best. Exotic investments are not a good idea.
5. The total cost of running a small business pension plan - including all of the accounting, advising, administrative and investment account fees - will average about 2.5% of assets per year.
6. Plan documents for a new pension plan must be established by December 31, 2014 but the plan can be funded later. We can set up new pension plans quickly, but please don't make us work too long on New Year's eve!
7. Small business pension plans have an average life of 8 years. While plans are intended to be permanent, it is important to be ready to adjust to life's unanticipated changes. That's where it helps to have an adviser who can consider the pension tax compliance issues with business and financial planning strategies for the best overall result.

  * Contributions vary depending on age, income and other factors. An estimate is available as part of a tax planning consultation. Actual allowable contribution is based on the actuary's report.

Other Resources

Pension plan design and contribution calculation example

Update on 412(i) pension plans: Use of life insurance and annuities in small business pension plans

412(i) self-employed pension plans

412(i) pension plan suitability