Most of our readers are regular W-2 employees working for a paycheck. But for you self-employed types out there – or if you know one and want to pass along the word – there’s a much bigger world of retirement options at your disposal.
We all know that the traditional pension plan is dead.
Unless your job is unionized or you work for the government, it’s extremely unlikely that you have a traditional, guaranteed pension to take care of you in your golden years.
Well, if you’re self-employed, I have good news.
You can actually create your own traditional, defined-benefit pension… and use it to shield a shocking amount of your income from taxes.
If you work for yourself and have no employees other than your spouse, you can start with an individual 401(k) plan. You can defer $18,000-$24,000 in an individual 401(k) plan, just as you can with a traditional employer-sponsored plan.
But here’s where it gets fun…
You can combine that one-man 401(k) with a cash-balance pension plan and potentially defer another $100,000-$200,000, or possibly more, depending on your age and income level.
Cash-Balance Pension Plan
For those unfamiliar with them, a cash-balance pension plan is a little different than what you would think of as a traditional pension plan.
To start, each participant has their own separate account; the participants aren’t pooled.
Investment options in cash-balance plans are often somewhat limited, but that’s by design. As ridiculous as this sounds, the pension obligation you owe to yourself is a real liability.
So if you invested the pension plan in something risky and lost money, you would owe yourself money… and you’d actually have to pay up.
Once you retire, you can generally roll the pension into an IRA, after which point you can invest in virtually anything.
If you’re self-employed, over 40, and in the 35% marginal tax bracket or above, then the individual 401(k) and cash-balance pension plan might be perfect for you.
I’ve seen this arrangement work particularly well for doctors and freelance consultants, but it’s generally a great option for any high-income earner who’s self-employed.
At the higher tax brackets, the tax savings can amount to hundreds of thousands or even millions of dollars over time.
My colleague John Del Vecchio does the bulk of his retirement savings via a cash-balance pension plan.
As you might expect from a professional short seller, John is extremely thorough and does his research. The fact that he uses this strategy for himself is a major endorsement.
I actually told a few folks in the office the other day: I’m surprised these plans are still legal. It’s like an IRA you can put $100,000 into every year.
You’ll definitely want to hire a professional for this, as screwing it up can create enormous liabilities for you.
As with all pension plans, there are actuarial assumptions that must be made and other arcane administrative headaches that are best left to specialists.
We’ve just moved passed Fourth of July, which means we’re at the start of the second half of the year. This mark is a perfect time to make sure you’re on your way to maxing out your retirement plans.
So I also explain a simple, helpful exercise to make sure you are. If you’ve followed my work before, you know I believe the tax-saving benefits alone are worth it.
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation in writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.
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