When the Rules Change
Pictured left to right: John D. Dovich president of John D. Dovich & Associates, Mark Strakowski president, retirement consultant, and actuary at Schneider, Male & Strakowski Co., and Dean Johns, Principal, CPA and CFP
Photo by Wes Battoclette
Advisors at John D. Dovich & Associates, LLC are urging business owners and professionals to consider breaking away from their single-component retirement plans in hopes of better preparing them for the future.
“Every profitable business owner and every professional who owns some kind of practice should be talking to their advisors about whether there are additional ways to improve their retirement plan,” says John Dovich, president at the firm.
Several factors have impacted the way business owners are saving for retirement. In 2013, tax rates increased dramatically, new Medicare taxes were implemented and the phase out of personal exemptions and itemized deductions returned. So for “successful business owners, the marginal tax rates are very high – upwards of 50 percent,” says Dean Johns, principal and CPA at the firm. “The magnitude of these tax increases are driving them to find ways to shelter more of their income.”
Not only are tax rates higher, but many people are realizing they don’t have enough money saved for the future. According to Dovich, with the “erosion of asset values in retirement plans during the Great Recession, a light bulb has been lit. Professionals are understanding that they need to save more money.” Yet some of these people are still unaware that to make that happen, their retirement plans may need to change.
That’s why, in a marketplace where rules have changed, Dovich says it’s the right time to have the retirement conversation with a financial advisor. But he recommends speaking to more than just an advisor and CPA. He also suggests collaborating with someone like Mark Strakowski, who spends the majority of his time creating and administering these types of plans.
Strakowski – president, retirement consultant, and actuary at Schneider, Male & Strakowski Co., E.A. – has seen firsthand the need for change in retirement plans. Recently, he spoke with a client who earned more than $1 million a year but was only using a SIMPLE 401(k), limiting his contributions to less than $20,000 annually. After educating the client and his CPA about the benefits of combining a defined benefit plan with a 401(k) profit-sharing plan, that same client was able to contribute more than $200,000 annually. The increased benefit for the owner had minimal additional cost to the other employees and was all tax deductible.
Although defined benefit plans can be very flexible and valuable to high-income earners who own professional practices or businesses, people don’t often consider them. That’s because the perception of these types of pension plans is misguided, mostly because “they’re falling out of favor in the corporate world and because of problems that are occurring in the public sector with unfunded pension liabilities,” Dovich says.
Generally, corporate plans such as the defined benefit plan cover all employees, so all employees benefit from them. But if investments don’t perform well, businesses have to use more of their own operational money to cover any funding shortfall. Because of that, many corporations see these plans as too much of a risk.
“But for smaller entities, there is more flexibility in plan design. For example, you can often couple the profit sharing plan with a defined benefit plan and design them so that essentially only the owners are benefitting under the defined benefit plan,” Strakowski says. “This eliminates the investment risk for the other employees’ benefits, which are being provided in the profit sharing plan, and allows the owners to increase their annual contributions.”
“There are many types of plans out there: IRAs, SEPs, 401(k)s, profit-sharing. We look at those plans first, but if business owners want to increase contributions for themselves above the limits of those plans, that’s when we introduce the defined benefit plan,” Strakowski continues. “For high-income earners who haven’t been saving enough along the way, the defined benefit plan is a very effective way to leverage up retirement plan contributions in a relatively short period of time.”
Below is a specific example of how a defined benefit plan can be used to generate very significant contributions for a business owner while keeping employee contributions to a reasonable cost level.
Defined benefit plans are not just for business owners. “We have physicians who are employed by private practices and hospital groups, but they also do research work or speak on behalf of drug companies. All that income is typically self-employment income,” Dovich says. “There are ways to shelter that income from income tax and create another source of retirement income.”
A defined benefit plan may be key to an early retirement. However, because it is more complicated, it may be advantageous to work with a team of sophisticated advisors, like those at Dovich & Associates, who can point you in the right direction and collaborate with the right experts.
John D. Dovich & Associates is located at 625 Eden Park Drive, Suite 310, Cincinnati, OH 45202. You can reach them at 513.579.9400 or visit their website at www.jdovich.com.
Schneider, Male & Strakowski Co., E.A. is located at 4520 Cooper Road, Suite 203, Cincinnati, OH 45242. You can reach them at 513.984.6100, by email at firstname.lastname@example.org, or visit their website at www.smsretirement.com.