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September 3, 2020

Increasing retirement and tax deferred savings for small business owners and the self-employed

As the presidential election draws near, business owners are reviewing the potential tax code changes being proposed by former vice president and current Democratic nominee Joe Biden. His proposals would alter certain provisions of the 2017 Tax Cuts and Jobs Act, increasing income, payroll and business taxes, primarily for taxpayers with taxable income over $400,000. The plan would also limit the tax benefit of itemized deductions to 28%. Given these potential changes, self-employed individuals and small business owners are exploring what vehicles are available to help defer taxes, while increasing their retirement savings. Traditionally business owners seeking an appropriate retirement plan would utilize a Defined Benefit plan or Defined Contribution plan, although each option presents certain concerns and limitations.

-Under a Defined Benefit plan, eligible participants receive a specific benefit amount as monthly retirement income for life. These plans were once fairly common and provided a secure retirement option for employers and employees. However, these plans are now viewed less favorably by employers as they bear the full responsibility for plan investment performance and plan costs, including any potential underfunding.

-By contrast, a Defined Contribution plan retirement benefits are based on the amount of money contributed to the plan and the investment performance. Employees can contribute to the plan directly through payroll and gain a tax advantage via pre-tax or Roth deferrals. Employers can opt to contribute or match employee’s deferrals to potentially avoid compliance testing. For employers a Defined Contribution plan offers cost certainty and minimal plan administration, but only allows for a limited contribution amount ($63,000 for those over age 50 in 2020).

Given the limitations of these traditional retirement plans, business owners are increasingly exploring other options such as a Cash Balance plan. A Cash Balance plan is a type of Defined Benefit plan that has characteristics of a Defined Contribution plan, primarily that the benefit is the participant’s stated account balance. This feature, which offers some cost certainty to employers, coupled with the higher contribution levels (up to $336,000, depending on age), makes a Cash Balance plan very favorable for employers or self-employed individuals looking to lower their tax obligation (via deductions for plan contributions) while significantly increasing their retirement savings. The potential disadvantages of a Cash Balance plan include the cost for actuarial services, as well as commitment to fund the plan for at least five years. Plan consultants can utilize employee census data to assist employers with understanding the potential contribution amounts and funding requirements prior to establishing a plan.

In short, small business owners and self-employed individuals looking to substantially increase their tax deferred savings, should act now to establish a Cash Balance plan for 2020.

This material presented is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. TrinityPoint Wealth, nor its investment advisory representatives are permitted to provide legal or tax advice, and nothing contained in these materials should be taken as legal or tax advice.

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