Minimizing Taxes and Protecting Assets for High-Income Earners
If you’re a business owner, professional, physician, or self-employed, and a high-earner, you may pay higher taxes than most Americans.
Individual income taxes are the IRS’s biggest revenue source and the top 50% of all taxpayers paid 97% of the total income tax paid.[i] The good news is that there are some financial options that you may be able to take advantage of to lessen your taxes and keep more of your hard-earned money. In this article, we will go over some of the basics of the Defined Benefit Plan (DB), the Defined Contribution Plan (DC), and Cash Balance Pension Plans.
Defined Benefit Plan (DB)
This style plan has lost popularity over the years, but as recently as the early 1980’s 60% of American workers had access to such a pension program. The number of DB plans is now down to 4%.[ii] Although less popular, DB plans may be worth taking a look at as an option. DB Plans are created with funds by the employer which will later be paid out in the form of a pension. When an employee reaches their retirement age they are eligible to draw on a fixed monthly pension. If you set up a DB Plan following the Employee Retirement Income Securities Act (ERISA) you would have a guaranteed amount to draw from once retired. While this style plan has fallen out of fashion in business, in part because of funding difficulties and extended lifetimes of retired workers, they can hold value for a high-income earner. This is in part due to changes in tax law that could help those with earnings too high to save 20% using the qualified business income (QBI) by using deductible contributions in a DB Plan to save on taxes.
Hybrid Defined Benefit/ Defined Contribution Plans.
Defined Contribution (DC) Plans, like 401(k)s have maximum yearly contributions. In 2017, the cash balance Creating a hybrid savings plan, a high-earner can securely move more of their assets into a plan which combines a DC and DB Plan. Having the two working in tandem is called a Cash Balance Plan will help offset the remaining taxable balance. The contributions are also protected from bankruptcy filings or creditors. These plans will also grow tax-deferred. The benefit of a hybrid plan for high-earners is the expanded options for investments once 401(k) caps have been reached. Older people can take real advantage of the generous contributions of over $200,000 yearly whereas a 401(k) can cap at $57,500.[iii] More businesses are seeing the benefit of cash balance plans to balance out unsustainable pension programs or 401(k)s that are coming up short. In 2017, cash balance programs went up 17% compared to a 3% increase of new 401(k) plans.[iv] This is in part because they are attractive to employers, providing tax savings of double or triple tax-deferred savings. They are also attractive to employers for their generous contribution.
If you are a high earner who has been focusing on your business or practice, at the loss of your retirement portfolio, looking into a Cash Balance Plan may be a great way to catch or accelerate your investments by maxing out the generous contributions. This is also a good way to save on taxes. As a business owner, the tax benefits can be very attractive for the above-the-line tax deductions which reduce income dollar for dollar. They can also defer taxes on contributions until retirement, meaning the income earned could be taxed at a lower rate. While cash balance plans aren't as well known, high-earners and business-owners can be rest assured they are also IRS approved. The plans above do have complicated rules and regulations, so the next step for anyone interested is to talk to a financial advisor, tax advisor, or qualified retirement planning consultant.
About the Author
Carroll W. “Bill” Hayes, MBA, CFP® Mr. Hayes started his financial career at Merrill Lynch in 1989. In 1992, Bill left Merrill Lynch for Fidelity Investments. During his career at Fidelity Investments he held roles in various divisions of Fidelity. Those roles included positions in the Trust, 401(k), Brokerage, and Money Management divisions. Bill held management positions at Fidelity and in 2001 led a Private Access team based in Boston. In the Private Access role his responsibilities included managing a book of business in excess of $3 Billion and a client base that was international in scope.
In 2008 Bill established Charles Carroll Financial Partners. The firm is an Independent FeeOnly Financial Planning and Investment Management firm. Charles Carroll Financial Partners embraces its fiduciary responsibility to its clients.
Bill is a graduate of Marquette University, and holds an MBA from the Sawyer School of Management. Bill holds the designation, CERTIFIED FINANCIAL PLANNER, and currently presides as a Commissioner on the Disciplinary and Ethics Commission of the Certified Financial Planner Board of Standards. Bill resides in Massachusetts with his wife Christine and travels up and down the East Coast meeting with clients of the firm.