Return of an Old Favorite
Sure, 401(k) plans get all the attention these days. But come Jan. 1, the old-fashioned ''defined-benefit'' pension plan could make a roaring comeback among boomer-aged entrepreneurs, thanks to laws that will expire at yearend. ''There's going to be a gold rush into defined-benefit plans,'' says Alan T. Nahoum, an actuary in White Plains, N.Y.
A defined-benefit plan--which provides you a fixed annual retirement payment -- allows you to put away far more than a 401(k) or other profit-sharing plan. But current law reduces the amount sharply if you've already put money in a defined-contribution plan such as a 401(k). That's a death blow to DB plans. A small company doesn't have the cash flow to support a lucrative defined-benefit plan when it's young, so entrepreneurs typically adopt a profit-sharing or 401(k) plan. By the time the company hits middle age and cash flow is strong enough to support a defined-benefit plan, says Nahoum, most of their eligibility is gone. Small wonder that only 4% of small companies have a DB plan.
But that law expires on Dec. 31, and experts say it won't be renewed. Just how much you could benefit will depend on your age. The rules allow you to put away enough money in a DB plan to fund an annual retirement income of $130,000 a year. In practice, this means that the older you are, the more money you can contribute to your nest egg. Steven Lockwood, a New York City pension attorney, estimates that switching from a profit-sharing plan to a DB plan can boost a 40-year-old's retirement hoard from a maximum of $30,000 annually -- the cap on profit-sharing plans -- to $70,000 a year, with the full sum deducted from your company's taxes. And an employee closer to retirement could salt away as much as $160,000 a year.
Some caveats: Don't try to fund both a 401(k) and a defined-benefit plan. Tax deductions are capped at 25% of payroll or your company's total DB contribution, whichever is greater, so the company and its employees would lose the 401(k) deduction. A DB plan costs about twice as much to administer as profit-sharing plans. And you need to pay an actuary and a lawyer to set it up. But the bottom line looks pretty attractive. ''It's a wonderful opportunity for baby boomers with underfunded pensions who want big income tax deductions,'' Lockwood says.
BY LYNN BRENNER
This article was originally published in the June 28, 1999 print edition of Business Week's Frontier. To subscribe, please see our subscription policy.
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