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Investing is Different with the Small Business Pension Program |
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A Sound Strategy |
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The Small Business Pension Program offers qualifying clients substantial annual tax savings over a short period of time in the years before retirement. It is important to remember that a defined benefit plan is an IRS approved type of qualified plan with annual required contributions. A portfolio that minimizes volatility is recommended. Large fluctuations in investment performance will result in correspondingly greater variability in annual contribution amounts. If the balances in a Small Business Pension Program increase sharply as a result of investment performance in a given year, the required annual contribution the next year will decrease. On the other hand, if the portfolio declines sharply, the required annual contribution will be increased significantly to offset the drop. When your client is close to retiring, it is particularly important to suggest investments that minimize the risk of a sharp decline in portfolio value since that client will have fewer years to fund the plan for the required benefit. |
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Annual Investing |
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Clients are obligated to make the annual contribution determined by the actuary once their plans are established. Opening a plan involves a commitment to invest significant amounts each year for the life of the plan. |
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Flexibility of Investments |
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Employers have the flexibility to diversify across a wide selection of investments. The employer's objective should be to primarily minimize portfolio volatility while attempting to maximize potential growth. In plans with employees other than the employer, the employer has a fiduciary obligation to the employees. This means that the employer is required to invest plan assets prudently, must diversify the investment of the plan's assets considering the liquidity and current return of the portfolio relative to the anticipated cash flow requirements of the plan, and the projected return of the portfolio relative to the funding objectives of the plan. |
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What Happens at Retirement? |
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In a defined benefit plan, annual benefits that are distributed from the plan are included in taxable income. Typically, an annuity is purchased to pay the annual benefit. However, IRS rules generally allow plan participants at retirement, age 62 or upon plan termination to elect a lump sum distribution payout option. The lump sum distribution would be fully taxable, so participants would typically choose to roll it over into an IRA where they may continue to grow tax-deferred. Maintaining the assets in a tax-deferred IRA creates the potential for continued investment growth and opportunities for estate planning strategies to transfer wealth to younger generations. |
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