Last Chance For Pre-Retired Professionals & Biz Owners

The stock market was volatile again last week but a more important news story affecting your wealth is an opportunity pre-retiree professionals and business owners should know about before passing up. This is like a highway exit you may not want to miss.

With just weeks before the end of the year, high-income lawyers, doctors, dentists and business owners are running out of time to reduce their 2018 tax bill while socking away a large sum in retirement. This strategy is particularly useful to professionals and business owners in their peak earning years who have not saved enough to retire.

The linchpin of this tax and retirement planning strategy is a defined benefit (DB) plan, a tax-advantaged vehicle that is not nearly as well-known as defined contribution (DC) plans but can be a potent vehicle for catching up on retirement savings fast.

With a DB plan, your retirement contribution is defined; your retirement benefit is not. DC plans pose less financial risk to employers, so they are much more common. The federal tax code imposes much higher contributions and elaborate rules on DB plans than on DC plans because a defined benefit is designed to last your actuarially-expected lifespan.

In 2018, the maximum contribution to a DB plan is $220,000 versus $55,000 for a DC plan. If a business owner has a DC plan already and now adds a DB plan, they could reduce their taxable income by as much as $275,000! If socking away $275,000 would make it impossible to meet current expenses, you can contribute less.

Consider a dentist in her peak earnings years, with $500,000 of income. She's married, and her children are out of the house. The 35% federal tax bracket bites deeply into her income.

Money she salts away into her qualified retirement plans is subtracted from her taxable income, reducing her tax bill for this year, and it enables her to lower her tax bracket to an optimum advantage.

Say she places $185,000 into the retirement accounts, it would reduce her taxable income to $315,000, putting her in the 24% tax bracket instead of the 35% bracket.

Because she is a partner in a business and it is not a "C corporation," she also qualifies for a 20% deduction under Section 199A of the new tax code for owners of small business that are S corps, LLCs, sole proprietorships, or other pass-through entities. To get this extra tax break, her taxable income must not exceed $315,000 for a married couple ($157,500 for a single).

Twenty percent of $315,000 works out to a deduction of $63,000, placing her taxable income at $252,000, firmly in the middle of the 24% bracket. If she hadn't taken steps to whittle down her high income, her taxes would much higher and she has socked away a large defined benefit for retirement.

Setting up a DB plan requires expertise and careful planning but is a great tactic to consider this year, especially because of 20% tax deduction. However, DB plans require careful planning and help from an actuary to evaluate the best way to set up your plan. Because of the technical nature of the work, it takes time, and you only have until the end of the year to get this done if you want to use this tactic to lower your 2018 tax bill and jumpstart your retirement savings plan.

The double-digit market correction of October that halted only a couple weeks ago and became a rally after the midterm elections fizzled. The market dropped sharply on Thursday and then bounced back strongly on Friday. The Standard & Poor's 500 closed at 2736.27, less than 8% off the all-time high of September 20. No one can predict the future, but the economy shows no sign of recession.

It's human nature to watch the market's ups and downs, but a single tax and retirement planning technique, like the DB plan idea outlined above, can net immediate income tax savings and jumpstart retirement savings for pre-retirees with more than $315,000 of taxable income in 2018.

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This article was written by a veteran financial journalist based on data compiled and analyzed by independent economist, Fritz Meyer. While these are sources we believe to be reliable, the information is not intended to be used as financial or tax advice without consulting a professional about your personal situation. Tax laws are subject to change. Indices are unmanaged and not available for direct investment. Investments with higher return potential carry greater risk for loss. Past performance is not an indicator of your future results.

Qualifying For The New Business Owner Tax Break

Under the new tax law, business owners are entitled to deduct 20% of "qualified business income." The test for qualifying for a tax break on 20% of business income is defined in the Tax Cuts and Jobs Act (TCJA) and summarized here along with a simple illustration.

If you formed your BUSINESS as a sole proprietorship, S corporation, partnership, LLC or similar pass-through entity, you are entitled to the deduction. C corporations don't qualify for the 20% deduction. Only businesses generating income not taxed at the company level, but directly to the owner.

Qualified business income is the business' day-to-day, non-investment income. It's revenue the business generates minus expenses.

QBI doesn't include interest, dividend income or capital gains on a property sale. Nor does QBI include salary or wages paid either as W-2 wages from an S corporation or guaranteed payments from a partnership.

However, the 20% deduction is limited to the lesser of:

• 20% of qualified business income, or
• 50% of the total W-2 wages paid by the business.

A separate limit based on the unadjusted basis of certain business assets could also apply, a rare situation.

More important: The 50% W-2 wage cap kicks in when a couple filing jointly has a total taxable income of more than $315,000 ($157,500 for singles).

Here's an illustration of a couple who owns a business with $200,000 in qualified business income, with no real assets, such as vehicles or real estate, and with one employee who was paid $50,000 in 2018. The couple would be entitled to QBI deduction of $40,000. That's 20% of $200,000.

Because the couple's taxable income is less than $315,000, the wage limitation - 50% of wages paid to their employee - is equal to $25,000 and would not apply.

Some business owners with more than $315,000 in QBI may want to consider reducing their W-2 wages or guaranteed payments to qualify for the deduction, but this requires careful planning and personal consulting beyond this simple illustration. The rules are new and technical, and before changing how your business pays you to qualify for the 20% QBI deduction, it's prudent to contact us and plan properly.