When you think about building a business exit strategy, you probably don’t imagine a retirement plan playing a major role. However, if you understand how to use defined benefit plans in the context of your exit, you could increase your chances of a sale, lower your tax burden, and supplement your retirement savings.
What Are Defined Benefit Plans?
Defined benefit plans, sometimes called pension plans, are not as prevalent as they once were. Many people regard them as a relic of the past, but defined benefit plans still have a place in today’s business landscape.
Before diving into how the right defined benefit plan may be an asset for your business, it’s important to understand the basics of how they work.
Common retirement accounts like 401(k)s and 403(b)s are known as defined contribution plans. The key difference between defined benefit plans and defined contribution plans comes down to how they’re funded:
- Defined Benefit (DB): The account holder receives a pre-determined monthly payment in retirement.
- Defined Contribution (DC): The account holder and employer contribute set amounts, but payout depends on investment performance.
Notably, employers who offer defined benefit plans carry all investment risks. Even if the plan is inadequately funded or performs poorly, the employer is still responsible for paying the pension.
Unlike 401(k)s and other retirement plans that mandate required minimum distributions (RMDs) once you turn a certain age, a defined benefit plan’s monthly payment amount is determined by a complex calculation. This calculation factors in your salary, how long you worked at the company, and several other factors.
How Defined Benefit Plans Can Maximize Your Exit Strategy
At first, it may seem like defined benefit plans have little to do with your exit strategy. However, if you open a defined benefit plan for yourself while you’re still with your company, you may enjoy a number of advantages:
Accelerating Your Savings
Ideally, you should open a defined benefits plan for yourself several years before your intended exit. Contribution limits for defined benefit plans are much higher than they are for 401(k)s, so you may make large deposits each year.
The contributions are tax-deductible, and they can significantly increase your retirement savings. This is especially advantageous if you think you haven’t saved enough but are nearing the end of your career.
Making Your Company Easier to Sell
When you contribute money to your defined benefits plan, you lower your company’s valuation, making it more attractive to potential buyers. If you anticipate having trouble finding the right buyer, this may be a strategy worth considering.
Receiving Tax Benefits at the End of Your Career
Contributions to defined benefit plans are made with pre-tax dollars. This means that any income tax on the funds in the account is deferred until you start receiving payments.
Additionally, because the money your company puts into the account is tax-deductible, you can reduce your business’s tax liability in the years before you leave.
Making the Most of Your Defined Benefit Plan
Defined benefit plans can strengthen your business exit strategy. However, if you don’t implement the plan properly, it could lead to unanticipated legal and tax consequences.
I often suggest that clients considering this option collaborate with legal and financial advisors before doing so. When you have the right professional guidance from the start, you are far more likely to reap the benefits of this unique strategy.
Ready to Build Your Exit Strategy?
Your business exit strategy should be just as unique as your business. At FinancialFocus Retirement Plan Services, we help clients harness the power of unconventional tools to build better futures. If you want to maximize your business exit strategy, contact us online or email me today at info@ff401k.com to schedule your appointment.
About Kenny Phan
Kenny Phan is a Managing Partner/Pension Consultant at FinancialFocus Retirement Plan Services. He works as a pension specialist who partners with financial professionals to design and implement pension plans. His area of expertise is customized defined benefit, defined contribution, and 401(k) plans. Serving financial advisors and businesses around the nation, he is supported by FinancialFocus Retirement Plan Services. Together, they provide comprehensive plan design consultation, administration, document installation, compliance testing, as well as IRS and DOL reporting for qualified retirement plans.