Dr Smith is a self employed physician age 30 who started an S corporation with no employees. After business expenses she has 300k in total revenue, she paid herself a W-2 of 200k, which would have left her with about 100k in profits. Dr Smith wanted to maximize her tax deductible contributions to a retirement plan so she could reduce the 100k in profits that would normally flow through to her as a K-1 distribution and would pay more income taxes.
The solution was a 401k profit sharing plan combined with a defined benefit plan. The 2016 total contribution was $78,430. $18,000 for the 401k + $12,000 for the profit sharing and $48,430 for the fully insured defined benefit plan.
As an alternative Dr Smith could have contributed 50k into a SEP IRA or 54k into an Individual 401k with 200k of W-2 salary. Compared to a SEP IRA the 401k/profit sharing/defined benefit plan gave Dr Smith an additional $28,430 tax deduction.
The $18,0000 contribution to a 401k is made using Dr Smith’s W-2 salary and this is tax deductible on her personal tax return. The profit sharing $12,000 and defined benefit $48,430 are tax deductible as a business expense to the S corporation.
Dr Smith liked this solution because it satisfied several goals:
- She was able to aggressively save for retirement and made an annual contribution of $78,430 in 2016.
- She was able to get a $78,430 tax deduction. Based on a 33% marginal tax bracket this saved her $25,881 in federal taxes.
- Based on an annual contribution to the defined benefit plan of $48,430, the minimum guaranteed policy value for the annuity at retirement age 62 on 8/1/2047 is $2,494,272.
- In addition she will have the value of the 401k and profit sharing plan.
In 2016 $30,000 can be made into the 401k and profit sharing plan. Annual contribution limits can potentially increase with future IRS increases to the contribution limits. The value of the 401k and profit sharing plan at retirement would be determined based on market performance. These values are not guaranteed. The 401k and profit sharing would supplement the $2,494,272 guaranteed minimum in the annuity in the defined benefit plan at retirement at age 62.
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