A Defined Benefit (DB) plan is a form of pension plan. Like a 401k or SEP-IRA, DB plan contributions are tax-deferred, can be invested in the market, and grow tax free without any capital gains tax. Unlike a 401k/SEP, where the annual contribution is defined (with a limit of $66k annually), in a DB plan, the amount you can contribute each year is different for every person, and instead, the amount of money the plan can hold (the “benefit”) is defined. Currently, DB plans can accumulate $3.15m before they are “done.”

The benefit of a DB plan over a 401k is that contributions can be much higher. For most high earning 1099 professionals, annual contributions can be as high as $200k. For someone making $600k/year, $100k DB contribution would reduce income tax by around $40k, and likewise, a $200k contribution would double that tax savings and reduce taxes by about $80k. In the past, pension plans were annuities. However, DB plans allow for something called a “Cash Balance” plan. In a Cash Balance plan, the full cash value of the plan can be rolled into an IRA and you only pay tax on the plan when you withdraw funds. 1099 Tax Doctor only uses Cash Balance DB plans.

DB plans require plan documents and annual actuary calculations, and special forms like a Schedule SB and 5500 must be signed by a licensed actuary and filed with the IRS each year. DB plans are therefore fairly expensive, with most third party administrators charging more than $2500/year, plus actuary fees, and setup fees. The cost of the plan is far outweighed by their ability to allow large tax-deferred contributions, thereby drastically lowering income tax rates. 1099 Tax Doctor does all this for you, essentially acting as the actuary and TPA for your plan.

DB plan funds are typically invested. Because plans are designed to grow steadily, and the actuary calculations for these plans assume a 5% annual ROR, most brokers will invest plan funds conservatively. Large brokerages do not give plan holders a choice in how they invest – they simply pay a 4-5% ROR annually. In order to be able to invest plan funds for a better ROR, you must typically go through an independent broker, many of whom charge 1-1.5% AUM. 1099 Tax Doctor has solved these problems by offering the ability to invest in custom portfolios based on risk tolerance, with the most aggressive portfolio investing a little more aggressively than most brokers. Our charge is only 0.40%; a rate unheard of in the DB plan market.

DB plans are meant to be long-term retirement plans, not short term tax shelters. Plans usually need to remain open for at least three years, and closing them earlier can invite IRS scrutiny. Valid reasons to close a plan would be that you no longer earn 1099 income, or you are disabled, or changed occupations. In these situations, you can close the plan and roll the funds into an IRA.