Defined Benefit Plans are a class of IRS-approved pension plans that allow for maximum contributions to be made to the pension plan. Unsurprisingly, this is a preferred tax saving and retirement planning vehicle for lawyers. Our research shows that lawyers are the major sponsors of small pension schemes in the United States.
The typical situation of each lawyer or law firms is the variable benefits/income. Income can shoot up in a particular year due to receipt of a payment from a large settlement and it would be prudent to contribute significantly more to a Defined Benefit plan in that particular year while suspending or reducing contributions in other years.
Lawyers that can benefit from a Defined Benefit Plan
- Lawyers with a small practice that has a few employees
- Lawyers who are solo practitioners without any employees
- Major Law firms with multiple lawyers and employees
Which type of business entity can sponsor a Defined Benefit plan for lawyers?
Business entities that can sponsor a cash balance plan are:
- Sole-proprietorships
- S-Corporations
- C-Corporations
- Partnerships
In short, any type of business entity can sponsor a Defined Benefit plan. The only thing that would be different is the way tax deductibility is claimed on tax returns.
If the lawyer receives 1099 incomes, they would normally declare that income as a sole-proprietor and file a Schedule C. The Schedule C income can be used to fund the Defined Benefit plan as well as be considered as compensation for the Defined Benefit plan. However, the tax deduction for the contribution to the Defined Benefit plan would normally be deducted on 1040.
If the lawyer has registered the business as an S-Corp, the compensation for the Defined Benefit plan would be gross compensation (typically Box 5 of the W-2) and the deduction would be taken on the Form the 1120S filed for the S-Corp
Examples of Defined Benefit plans for lawyers:
Defined Benefit Plan for Lawyer who is self-employed and does not have any employees.
Let’s assume the lawyer is 45 years old and has not incorporated the practice and files their taxes as a sole proprietor.
Let’s also assume that the Schedule C for the past three years has been at least $200,000 and no contributions were made to any type of pension plan.
Use our defined balance plan calculator to find out how much you can contribute by age and income.
Defined Benefit Plan for Lawyers who has a small practice and a few employees
Let’s assume our lawyer, in this case, is 50 years old and has incorporated the business as an S-Corp. The W-2 income from the business is $280,000 and three other full-time employees assist the lawyer in the practice.
A participant with the above-mentioned parameters can accumulate $2,621,923.68 till s/he reaches the assumed retirement age of 62. During the first year, a maximum contribution of $166,267.00 can be made to the plan.
Defined Benefit Plan for Lawyers with a growing practice wherein ownership will be offered to new lawyers over time
This is a typical situation for a practice that is started by a lawyer who hires another lawyer who will slowly buy into the practice while making it grow. This team could continue to expand and the Defined Benefit plan could be an excellent incentive to hire lawyer contractors while offering significant compensation in a tax-deferred manner.
In this situation, the Defined Benefit plan might have different classes with different levels of Defined Benefit contributions:
- Class 1: Owner Lawyer
- Class 2: Nonowner, lawyer
- Class 3: Lawyers who are highly compensated employees (as per the definition of the IRS)
Lawyers with a small practice
Employees play a crucial role in a small practice because a good employee can relieve a heavy administrative burden on the lawyer. The cost and effort to train and retrain new employees are substantially higher and it may make more sense to add additional pension benefits to the employee’s package.
In such a situation, the lawyer can include key employees in the Defined Benefit plan where the benefits increase with years of service. The plan can also implement a vesting schedule, making the employees earn vesting through years of service.
Benefits of Defined Benefit Plan for Lawyers
Lower taxes: Lawyers are almost always in the top tax brackets, regardless of age. In this situation, tax planning is an imperative goal for long-term financial well-being. DB benefits offer large tax deductions and help reduce your taxable income.
Liability Protection: Money held in a Defined Benefit plan is protected against lawsuits that are still a major threat.
Saving for Retirement: Based on current IRS maximums, a Defined Benefit plan allows a lawyer to save as much as $2.8 million in the plan in a tax-deferred manner. The spouse can also be employed in the practice and that can increase the total lump sum that can be accumulated in the plan.
Employee Retention Strategy: As described earlier, this plan can be used to promote employee retention, which has many non-quantifiable benefits.
How to set up a Defined Benefit plan for lawyers?
Setting up a Defined Benefit plan requires some basic work that needs to be done before you can start contributing to the plan. As lawyers are very busy, we recommend that you leave the finer details with us by emailing info@pensiondeductions.com.
What is the deadline to contribute to a defined benefit plan for lawyers?
We specialize in setting up defined benefit plans for lawyers and a significant amount of our clientele are lawyers. We understand exactly how busy you are and what your objectives are. Feel free to send us an email at info@pensiondeductions.com and we can provide you with a free contribution estimate based on your specific situation.
