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Posted

Question  - when is the best time to terminate DBP now, 2019, 2020, etc?

Client 52 year old, wholesale business owner where he is the sole employee.  The business is setup as a sole proprietorship and he has a DBP, Solo401(k) and PSP. Client wants to retire at age 55 - July 2020.

DBP is already overfunded by 2.5%, as of today 2/26//2018, for the Lump Sum @ Ret calculated for age 55.

Client has not made any contributions to the DBP for 2016 and 2017 due to the anticipated overfunding. Thus is he receiving no tax benefit having the DBP other than time passing. 

The assets of the DBP are presently in money market account earning 1% in Vanguard Federal Money Market Fund (VMFXX) since why risk with equities when any gains results in overfunding tax.

Business owner anticipates

2018 Business profit at least $130K

2019 Business profit projected at $50K

2020 Client would sell some of their premium web domain names and therefore would have a business profit

Client has never reported a business loss, but could report 2 years before finally closing business.

So that would be 2022 to terminate DBP, then roll over to a IRA and by then there would be no overfunding issue.

Think keeping the DBP going until 2022 would allow deferring income earned in 2018 & 2019 for $61,000 each year (DBP $0, 401(k) $18,500, catch-up $6,000, PSP $36,500), 2020, 2021, 2022 the business is not expected to make much of a business profit.

I feel this is the best approach but interested an anyone’s feedback.  There would be no more contributions to the DBP and the business would have no income in 2021 and 2022.

If we terminate the DBP now excess assets revert to the employer, they are subject to two taxes:

1.            Business income tax because the excess assets have not been previously subject to taxation.

2.             A non-deductible excise tax of 50% of the amount of the excess assets.

The way to potentially avoid paying the excise tax is to transfer the excess assets into PSP. The excess assets will be used to make the employer allocations. Since they had been deducted, would not be able to deduct these amounts again on client’s tax returns.

Client will start paying expenses for the DBP maintenance and accountant fees that would draw down some of the excessive funding.

If we did terminate the DBP now the excess assets would be used for (401(k) $18,500, catch-up $6,000, PSP $36,500). The issue here client knows business income will be over $130K for 2018 and could push some business income from 2018 into 2019 so business income of $55K is possible. But there would not be enough time or business income to use up the transferred excess assets and client wants to retires from the business. Client does not see selling the business is possible and will just close down. 

Some of the other strategies for mitigating overfunding DBP are not applicable to client’s situation

  1. Increasing plan benefits since client is at the maximum permissible (415) benefit level

  2. Bring new participants into the plan. Client is 1 person business, single, no kids

Thank you for your time reading my post and your feedback is welcomed.

Posted

Correct.  

BTW, you start a paragraph with, "The way to potentially avoid...".  When you hire a pension actuary, you will learn that is not the only way to "avoid".

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

Posted

One thing to keep in mind is that the applicable maximum lump sum may increase as time passes, depending on the details of the situation.  I agree though, if you have an actuary look at the specifics of the plan, they should be able to tell you if this is likely to be the case for you client and give you a better idea of the available options.

Posted

Mantee thank you for your reply

There is an actuary that does the Defined Benefit Plan Annual Actuarial Reports.  It is the same actuary has done the Annual Actuarial Reports, Form 5500-EZ, supporting Schedule SB and Participant Benefit Statements for distribution for the past 15 years.

The actuary holds the designation EA, FCA, MAAA but does not want to make a statement to terminate the DBP or let time pass. Instead the actuary states they do not provide tax advice. The client's CPA (with a MST from Bentley College) does not want to make a recommendation since the CPA does not have a lot of experience with clients using DBP, Solo401k, PSP and the CPA recommended seeking a tax attorney.

We tried searching for a tax attorney that specializes in a single participate DBP but the law firms all seem to deal with large businesses with 100's or 1000's of participate. The DBP we are looking for answers has one(1) person.

If anyone of this forum does know of a qualified tax attorney I welcome their name and willing to pay for their services.  We are just looking how best to handle the situation and making the best decision with something in writing so there is a plan in place on when to terminate the DBP and roll into an IRA.  The business owner would like to start taking distributions at 59 1/2 but he can delay this.  The business owner does have a SEP when he first started the business and then ended contributions to the SEP and started the DBP, Solo401k and PSP since it allowed him to defer more income. He also has an IRA when he worked in the private sector and retirement savings plan when he was a state employee. 

So there are lots of different deferred compensation plans and need advice and a written plan when the time comes to start taking distributions while seeking maximum tax efficiency.

I thank you for your time reading this posting.

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