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Higher Income Tax Rates Require More Advanced Income Tax Planning: The Defined Benefit Plan Can Generate Huge Income Tax Deductions!

Higher Income Tax Rates Require More Advanced Income Tax Planning:
The Defined Benefit Plan Can Generate Huge Income Tax Deductions!
Effective January 1, 2013, the top marginal federal income tax bracket increased to 39.6%. When taking into account New York State and New York City income tax rates, an individual earning more than $400,000 or a couple earning $450,000 per year could have a marginal income tax bracket in excess of 50%. Finding legitimate income tax deductions to offset onerous income tax rates is essential.

Under current tax law, there are very few allowable deductions. However, a very important deduction is the deduction for qualified retirement plans, including a defined benefit plan. A defined benefit plan is a qualified retirement plan under the Internal Revenue Code that in many circumstances can generate above the line annual income tax deductions in the many hundreds of thousands of dollars as well as significant retirement assets for the self-employed and small business owner. All contributions into a qualified defined benefit plan are 100% tax deductible. Since these plans generate “above the line” income tax deductions they are the perfect way to reduce current income tax liability for federal, state and city purposes while saving for retirement. For example, a taxpayer earning $1 million dollars per year with a defined benefit plan contribution of $200,000 would only have $800,000 in adjusted gross income potentially saving $100,000 in current income tax liabilities!

For those that qualify, defined benefit plans also allow significantly larger contributions than a typical 401(k), profit sharing or money purchase plan. Individuals who are 50 years of age or older could potentially contribute in excess of $300,000 per year. The goal of this type of planning is to maximize owner contributions while minimizing employee cost. Any plan must of course comply with all IRS requirements. The contributions are actuarially calculated based on the employee’s age, income, assumed retirement age and the plan’s assumed and actual investment performance. Under current law, a defined benefit payment can be designed to pay at the participant’s retirement age as much as $205,000 per year for life. If someone retires at age 62, many millions of dollars would have to be accumulated in the plan in order to receive $200,000 per year for life. Since, the size of the contribution (and the deduction) is calculated using a compounded present value calculation, the largest contribution (and deduction) will be enjoyed by taxpayers who have a shorter number of years until retirement. For example, an owner/sole proprietor with 10 years of plan participation could retire at age 62 with a lump sum of $2,480,000 given the right salary, coverage and effective investment guidance. This amount could increase to $3.7 million if the plan adjusts pay-outs for cost of living increases. In addition, an equivalent amount can be set aside for the owner’s spouse if the spouse is an employee in the business and the spouse earns at least $250,000 per year. These benefits clearly cannot be achieved with a simple 401(k) or profit sharing plan where contributions are limited to only $50,000 per year.

While a defined benefit plan is somewhat more expensive to maintain than some other qualified plans, it should be considered by any business owner who is looking to maximize his or her assets at retirement and substantially reduce current income tax obligations. Given the rising tax environment, now is the time to take action.

In addition to generating very large income tax deductions, in many cases, a portion or “incidental” portion of the retirement plan can be used to pay for life insurance that may be desirable or necessary for your estate planning. Pre-tax money would be used to pay the premium. If the plan and life insurance are structured properly, a vast portion of the life insurance proceeds can escape estate taxation even though pre-tax money was used to pay the premium.

If you wish to discuss the information described above for yourself or for your clients, please contact Maurice Kassimir at 212-944-1377 or mkassimir@mkpclaw.com to see how you can plan today for a substantially better tomorrow.

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If you are looking for the very best legal advice in estate and succession planning, or estate and trust administration, contact the law firm of Maurice Kassimir & Associates, P.C.

(212) 944-1377

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