Case Study: How to Save Money Through a Financial Crisis - Defined Benefit Plan

Scenario: 

Six years before retirement, a couple, one of which was a corporate executive and the spouse, a self-employed entrepreneur, came to me because they wanted to save the maximum before they retired. When a client says they want to save the maximum that can range from up to the company match in their 401k (4% of salary) to 100k plus per year. 

Challenge: 

It was the mid 2008 the financial crisis was just gaining momentum, only we didn’t know it yet. 

Solution: 

The corporate executive was already saving the maximum in her 401(k) and continued to do so from 2008 (20,500) thru 2014 ($23,500k). The self-employed entrepreneur was making around 200k and was 61 years old and wanted to set up a plan to shelter his self-employed income.

The self-employed partner wanted to save more than the 50k that was available in a single 401(k) during the 2008 time frame. We explored a defined benefit plan (DB) because that would allow the client to save significantly more than a single 401(k). The single 401(k) could be paired with the defined benefit plan for extra deferral, if desired. The ideal profile for a defined benefit plan is: Candidates in their low 60’s, self-employed and no employees, which this client fit.  We completed the paperwork and set a target contribution rate of 100k per year for the defined benefit plan and they were off and saving. 

They contributed about 700k between 2008 and 2014 to the DB plan all of which was tax deductible. In addition, during the early years they contributed to a Roth 401(k) when the market was low and that money grew tax-free. The beauty of the DB plan is that you typically want to have a conservative portfolio because you want to try to achieve a target rate of return around 5% to get stable returns so you will have predictable contribution amounts. The portfolio we constructed was on the order of 75% bond funds and 25% stock funds and that worked very well during the drop in the markets in 2008 & 2009 because we dollar cost averaged the funding for the plan over the whole time frame.

Result:

In the end the self-employed client contributed over 700k to the Defined Benefit Plan, which resulted in about 140k of tax savings over the 7-year period. We rolled over the Defined Benefit Plan to an IRA and the Roth 401(k) to a Roth IRA. For the corporate executive, we rolled over her 401(k) to an IRA.  They were now set for retirement and can continue to enjoy life without the worry as to how to create their retirement paycheck.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

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