Right Pension Plan Can Help Businesses With Year-End Tax Planning
Cathy Cabrera and her husband, Rick Ungar, are textbook examples of business owners who understand the tax implications of careful pension planning.
They own Brentwood Television Funnies Inc., a Lake Arrowhead producer of children’s television programming. They had nothing more complicated than IRAs 10 years ago when they began thinking about their retirement.
Then they got serious about planning for it, and since then they have had, in order:
* A profit-sharing plan;
* A “layered” profit-sharing and money-purchase plan;
* The most flexible of all pension plans--a defined benefit plan.
Cabrera and Ungar don’t disclose the details of their company’s revenue or profit, but what they do say tells a vivid tale about the impact of a good pension plan on taxes: Their own pension enables them, every year, to salt away $95,000 to $135,000 for themselves and three employees, cutting their corporate and personal income tax bills to the bone and putting them in position to enjoy a secure retirement.
As outlined in this space last week, for most businesses year-end tax planning means timing business income and expenses to keep the tax collector at bay.
But since tax law considers pension contributions a business expense, a solid pension plan gives you two big benefits:
* A deduction against business income equal to your contribution;
* A tax-sheltered way to save for retirement.
The key is to determine what kind of pension plan works best for your business and its employees, and to get it in place before the end of your tax year, according to Cabrera and Ungar’s financial advisor, Neil Finestone, a partner in the Sherman Oaks financial advisory firm Tow Finestone & Associates.
For unincorporated businesses, the tax year is the calendar year, so the chance to do something about a pension plan for this year runs out this week. Incorporated businesses may elect fiscal years that do not coincide with the calendar year, so they don’t face the same urgency in December.
Finestone notes that for most small and mid-size businesses, pension plans come in three types:
* A profit-sharing plan, for which contributions may vary between zero and 15% of net income and may change from one year to the next;
* A money-purchase plan, for which contributions may range to 25% but remain fixed once elected;
* A defined benefit plan, for which contributions may exceed those for profit-sharing or money-purchase plans and reflect such factors as the participant’s age and income, the target annual benefit sought at retirement and the performance of investments held by the pension.
Like many other business owners, Finestone said, Cabrera and Ungar started with a profit-sharing plan, added a money-purchase plan, and ended up with a defined benefit plan for one simple reason: As their business grew, so did their desire to shelter income from taxation and provide for their own retirement, and each plan enabled them to salt away progressively more money.
Federal law caps contributions to money-purchase plans at $30,000, so business owners with big incomes find defined benefit plans more attractive, Finestone noted. A 50-year-old earning $200,000, for example, could put away as much as $88,000 to $98,000 of it in a defined benefit plan--almost half of his or her income and far more than allowable in a money-purchase plan.
“As you get older and reach your peak earning years, you tend to look seriously at the needs of your retirement, and that often means setting up a defined benefit plan,” Finestone said. “The older you are when you set a defined benefit plan up, the larger the potential deduction.”
Whatever the type of pension you set up, it is first and foremost an employee benefit plan. But in the eyes of people like Cathy Cabrera, the real plus is that you shelter big chunks of your income from taxation.
“I get on my soapbox all the time telling people that they have to fund their own retirement,” she said. “And when I find someone whose business situation fits the parameters of a defined benefit plan, I tell them that what they’re really getting is a divine benefit plan.”
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Next: How to structure your business income tax return to satisfy the government and your financial statements to please your lender.
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Recent Financing and Insurance columns are available at https://www.latimes.com/finin. Juan Hovey can be reached at (805) 492-7909 or at jhovey@gte.net.
