Using a Defined Benefit Plan to Defer Income After Selling Your Business
After a nearly three decade long career as a dentist, Tom began looking for a buyer for his practice. Once an interested buyer was located, we were called to advise Tom on the most advantageous way to structure the purchase. Seeing as Tom had saved a good nest egg while he was practicing, he didn’t need the proceeds from the sale or the consulting work to cover living expenses. In fact, Tom preferred to defer all the income he could.
The details of Tom’s situation included:
- The practice operated as a C Corp
- $200,000 purchase price for practice assets
- Tom would sign a 3-year consulting contract for $200,000/yr.
- There was an existing 401(k) plan for Tom and employees
The MGO Solution
We proposed a Defined Benefit Plan for Tom’s business. Why? A defined benefit plan does not require current income in order for a benefit to be provided. The benefit can be based on the three highest consecutive years salary over the working lifetime. Tom’s 3-year average high wage was $220,000.
Based on Tom’s age, a defined benefit plan can be established. It can be structured whereby the lump sum benefit payable to Tom would be $880,000 after 4 years. According to IRS funding rules, contributions could be $200,000 per year, allowing Tom to defer all the income from the sale of the business as well as all of his consulting income, resulting in a tax savings of nearly $320,000!
Once the corporation ceased to exist - following Tom’s final year as a consultant - the plan can be terminated and the monies rolled over into an IRA where it will continue to grow tax deferred. Tom will only pay taxes as he uses the funds and he will be required to begin taking distributions at age 70 1/2.
The sale of Tom’s practice went through as designed. He contributed the purchase price of the practice, some $200,000 in the first year of the plan. In the three subsequent years he contributed the money from his consulting contract, an additional $200,000 per year. At the end of the fourth year Tom decided he no longer wanted to consult and terminated his contract and rolled the funds into an IRA.
Today, Tom is enjoying life in retirement and continues to defer the income tax and gains from the sale of his practice.