The ability to deftly use qualified retirement plans is extremely valuable for business owners. Retirement solutions can be considered a wealth enhancement service and, as such, it falls under the umbrella of advanced planning.
In a survey of 513 business owners, 37.2% had a qualified retirement plan (either a defined contribution or defined benefit plan) and 62.8% did not.
Among the companies with retirement plans, the monies tend not to be meaningful for the business owners. Only 16.2% said these funds are “important” and 55.5% described the plans as “somewhat important.” The remaining 28.3% said the funds in the retirement plans are “not important.” This is usually a function of the business owners not having significant sums in their qualified retirement plans for any number of reasons, such as the plan being “top heavy.”
Among the 322 business owners who did not have company retirement plans, the reason cited by three-fifths of them was cost (see chart). More than 40% of the business owners said such plans do not give them any direct benefits. About 35% said that difficult business conditions made offering qualified retirement plans unfeasible. And almost 30% were concerned about liability.
Clearly, many business owners are not taking advantage of qualified retirement plans and, as a result, are missing out on some important opportunities. Here’s a small sampling of what retirement planning and qualified retirement plans can accomplish:
• A law firm pays partners retirement benefits from the general assets of their partnership or a limited liability company. Such firms typically have 401(k) plans that offer minimal benefits, making it possible to provide significant tax deferrals for each partner (from $2 million to $5 million), reduce payroll taxes, provide tax-deductible life insurance and protect capital and retirement benefits in case of bankruptcy.
• A start-up private equity firm tends to use the same structure for management fees and carried interest on investment fund performance. These structures have been in place for 40 years, and Congress is currently focused on increasing taxation on the carried interest. Using different structures today can increase the return on investment for the private equity partner or hedge fund manager by 20% to 40%.
• A construction company has been in business for 50 years and the founder would like to sell the business. However, because the company participated in several multi-employer union defined benefit plans, the business valuation has been significantly reduced because of a $40 million multi-employer repurchase liability. The business owner executes a strategy that mitigates the impact of the repurchase liability and offers bankruptcy protection and other benefits.
• A small company has a pension plan that is underfunded by $15 million, significantly impacting the business’s growth and expansion. It’s possible to enable the business owner to fully fund the pension while fulfilling her growth and expansion aspirations.
• An employee-owned company has a $23 million repurchase liability with regard to employee retirement obligations. This liability has impacted the growth of the business. It’s possible for the company to reduce the impact of the repurchase liability so that the business can continue to grow while meeting the repurchase obligation.
• A small business has a frozen pension plan that is overfunded by $17 million because of government funding requirements and market appreciation. The excess assets can be used to improve retirement benefits and be invested in the business on a pretax basis.
Conclusions
Most business owners are not taking advantage of retirement solutions for a number of reasons, including costs, a belief that they have no direct benefits, an uncertain business environment and liability concerns. However, a talented advanced planner can probably identify a number of potential retirement solutions that would be highly beneficial to the business owner.
Timothy Desmond, CPA, is a partner at O’Connor Davies and serves as the firm’s director of employee benefit services. He has over 25 years of experience providing auditing and accounting services to industry organizations and employee benefit plans. He can be reached at tdesmond@odpkf.com
John N. Vitucci, CPA, is a principal at O’Connor Davies and has more than 30 years of experience working with Fortune 500 corporations and alternative firms in all areas of employee benefits and ERISA. He can be reached at jvitucci@odpkf.com
