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Pension plan design and contribution calculation example
by Tony Novak, CPA, MBA, MT last updated on 12/1/2011
This is meant as an example of a simplified small business pension plan designed specifically to maximize tax-deductible contributions to the owner. The data is based on 2004 tax law; the results may change slightly in future years. This is an "extreme" example that would not be used in most tax-qualified health plans. Most pension plans will use more moderate assumptions. The actual assumptions and deductions will vary depending on actual circumstances.
Assumptions:
The maximum annual benefit the pension plan may provide is $165,000. (This amount will increase each year).
Current age is 45.
Life expectancy is age 97.
Early retirement age is 55.
Number of year to retirement is 10.
Number of years of pension benefits is 40 (Calculated as 95 minus 55).
Interest rate is 3.5%.
Compensation for each of the past three years is $500,000 that is not needed for living expenses.
The business has no previous pension plan.
The financial planning goal is to maximize the current tax deductible retirement plan contribution.
Calculation:
Maximum target account accumulation at early retirement age is $3,523,587. (This is the investment goal).
The first year contribution to fund this benefit is $300,355. (This is the maximum annual tax deductible contribution. The contribution amount may stay the same in future years if actual financial results are the same as the expected results. A deviation in actual results may change the contribution in future years).
Online retirement calculator
Yahoo Finance offers an excellent free and easy-to-use financial calculator that handles the retirement plan contribution calculation for most common situations. The calculator has a limit of 40 years of retirement income so it may not be used when the expected retirement age is 55 and the life expectancy is greater than 95.
A calculation of the maximum allowable tax-deductible contribution is available as part of my tax planning consultation service. This calculation is an estimate; the actual allowable amount is based on an actuary's report.
Additional resources
Pension plans for small businesses
412(i) self-employed pension plans
412(i) pension plan suitability
Update on 412(i) pension plans: Use of life insurance and annuities in small business pension plans
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Opinions expressed are the solely those of the author and do not represent the position of any other person, company or entity mentioned in the article. Information is from sources believed to be reliable but cannot be guaranteed. Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues or a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Tony Novak operates as an independent adviser under the trademarks "Freedom Benefits", "OnlineAdviser" and "OnlineNavigator" but is not a representative, agent, broker, producer or navigator for any securities broker dealer firm, federal or state health insurance marketplace or qualified health plan carrier. He has no financial position in any stocks mentioned. Novak does work as an accountant, agent, adviser, writer, consultant, marketer, reviewer, endorser, producer, lead generator or referrer to other companies including the companies listed in the articles on this web site.
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