You’ve researched the Defined Benefit (DB) Plan. You’re well-informed of its qualifications and complexities. You’ve pitched it to a few of your high-income clients.

Then come the objections. Are you ready for the pushback?

Let’s tackle the top five myths your clients might raise about DB Plans – and how you can put their concerns to rest.

Myth 1: You have minimal investment options.

The most common myth about the DB Plan is the belief that investors are limited in their investment choices. They believe that because these plans are “defined,” then their investment options are restricted. High-income clients don’t like restrictions – they want options. The good news for them – and you – is that DB plans have “open architecture.”

Open architecture refers to plans where a client can invest in anything available (for the most part). So, if your client’s DB Plan is set up through a custodian like Fidelity, your client can access a wide range of investment options. From stocks to mutual funds to bonds, the opportunities are vast!

The architecture of a DB Plan is dependent on the custodian. When partnering with a DB Plan specialist, ask about their custodian. You want to partner with a specialist who uses open architecture custodians.

While the variety of investment choices for a DB Plan are impressive, there is a small catch. Your clients must not take on too much risk.

A DB Plan assumes a certain rate of return in its actuarial calculations. For example, if the plan targets a 6% return, and the investments mix is targeting a higher rate of return, your client could end up taking on too much risk (i.e., losing too much money in a bad market) that could jeopardize the future stability of their retirement payouts and require them to contribute more in order to stabilize their future payout.

The investment choices for a DB Plan are nearly unlimited. But you must emphasize to your clients that the investments within the account must be closely aligned with the return assumption made in the plan. They can be more aggressive – take on higher risk – with other accounts.

Myth 2: You have to contribute the same amount every year.

Most high-income clients fear that once they sign up for a DB Plan, they’re locked into contributing the same amount each year. But DB Plans are more flexible than investors think, and they aren’t tied to a fixed contribution.

When it comes to DB Plans, investors are allowed to make adjustments within a certain range. For example, if your client’s plan requires a contribution of $100,000 one year, they may be able to contribute anywhere from $80,000 to $120,000 the next year (depending on their financial situation and the performance of their investments).

If an investor’s income fluctuates significantly, they can modify the contribution structure without breaking the rules of the plan. And, in the event of extreme financial hardship, such as a poor business year, it’s even possible to freeze contributions temporarily.

Myth 3: You can’t make adjustments if your circumstances change.

Closely related to the myth above is the misconception that investors cannot make any adjustments to a DB Plan if their circumstances change. Small business owners may turn away from DB Plans, fearing that if their circumstances change – if they have a bad year or two – then they won’t be able to keep up with contributions. Fortunately, DB Plans are designed with the understanding that life happens and circumstances shift.

The DB Plan rules allow for adjustments based on significant changes in your client’s financial or business situation. For example, one high-income client – a business owner – originally set his plan to contribute roughly $120,000 annually. However, his income was steadily increasing. So, he amended the plan to allow for even greater contributions, taking advantage of the higher tax deduction.

In another case, a business severely impacted by the COVID-19 pandemic was able to freeze contributions for an entire year. This offered them much-needed relief during a difficult time.

Remember: Your clients are in charge of these plans. As long as they follow the rules, they can change and amend the plan to fit their needs.

Myth 4: You have to contribute a lot for your employees.

Often, high-income clients believe that a DB Plan is an individual plan. This isn’t true. A DB Plan is a plan for the business. Once business owners learn this, they grow wary. They think that they must contribute significant amounts of money for every employee who qualifies under the plan. Usually, they dismiss the DB Plan, believing that the costs will outweigh the benefits.

Yes – business owners need to make contributions for employees who work more than a certain number of hours a year. But there’s a catch! Business owners can classify contributions in different tiers. Meaning, a business owner can earmark more for themselves while setting aside a much lower dollar amount for employees.

For example, a business owner may contribute $150,000 annually for their own retirement but only $5,000 for each of their employees. These contributions then serve as a benefit to employees, similar to a 401(k) match. The DB Plan contributions can be managed in a way that maximizes the owner’s benefit while still providing value to their staff.

Again, your client has control over how much goes into each employee’s plan, and it can be significantly less than the amount they contribute for themselves.

Myth 5: You have to take the income like a pension at the end.

Your high-income clients may avoid a DB Plan because of its end result. Too often, they believe they are required to receive a predetermined monthly income for the rest of their lives, similar to a traditional pension. The reality is much better: Investors have flexibility in choosing how they receive their money.

For most investors upon retirement, it’s recommended they roll over their accumulated funds into an Individual Retirement Account (IRA). Unlike an annuitized pension, which locks an investor into a fixed income stream, the IRA allows clients to retain control over how and when to withdraw money.

By rolling the money into an IRA, investors can continue to grow their investment and choose their own distribution schedule. Your clients can have more control, allowing them to better manage taxes and plan for future expenses.

Annuitizing may offer investors a sense of security, but it’s not required. A majority of investors choose the IRA option for greater flexibility.

For more information about Edge Financial Advisors and the Defined Benefit Plan, visit https://www.yourretirementaccelerator.com/, or you may schedule a conversation to discuss your client’s needs.

Question: Ryan has a Schedule C business where he has a piece of 5-year class life equipment that he placed in service in 2022. The equipment is qualified property and eligible for bonus depreciation; however, when Ryan timely filed his 2022 tax return, he did not claim bonus depreciation and did not elect out of claiming bonus depreciation. He has also timely filed his 2023 return, continuing to claim depreciation on the asset. Realizing that he should have either claimed bonus depreciation or elected out, Ryan wants to amend his 2022 return to claim bonus depreciation since he is still within the statute of limitations. Can Ryan amend his 2022 tax return to claim the bonus depreciation he was eligible to take?

Answer: No, Ryan cannot amend his tax return to claim bonus depreciation. Instead, he must file Form 3115, Change in Method of Accounting, to claim the missed bonus depreciation. The return is past the due date; therefore, Ryan cannot elect out of bonus depreciation. Because no affirmative election-out was made, Ryan is required to compute depreciation and basis of the equipment as if bonus depreciation was taken; therefore, he should file Form 3115 to claim the missed depreciation to receive the benefit of the deduction. In instances where a taxpayer timely files their tax return without affirmatively electing out of depreciation, they can go back and make the election-out on an amended tax return within six months of the due date of the original return, excluding extensions, and writing “filed pursuant to Section 301.9100-2” at the top of the return. Because Ryan’s return is past the six-month mark, he should file Form 3115 to claim the missed bonus depreciation since no affirmative election-out was made.

Reporting the sale of a rental property involves understanding capital gains, depreciation recapture and specific tax laws. The sale may not seem that complicated, but there can be unexpected tax liabilities the client didn’t consider.

Below, you’ll find a few of the top questions from a recent webinar on the topic and their accompanying answers. If you choose to attend the on-demand version of this webinar, you can access the full recording and the entire list of Q&As.   

Q: How do you handle a sale of a property that was first personal, then rental, and then moved back to personal use?

A: The rental period counts as nonqualified use. Additionally, any depreciation taken during the rental period is taxable to the extent of gain on the sale and cannot be excluded under the §121 exclusion rules.

Q: If §121 excludes all taxable income from the sale, does the taxpayer still need to report it on their tax return?

A: No. If the taxpayer meets the §121 ownership and use requirements and did not claim depreciation on the property, they do not need to report the sale on Form 1040.

Q: What if the rental room is part of an apartment that the person does not own? Is depreciation allowed?

A: Depreciation cannot be claimed on property that the taxpayer does not own.

Q: What happens to suspended passive losses if the rental property becomes the taxpayer’s primary residence?

A: The suspended passive losses remain suspended until the taxpayer either sells the property or their adjusted gross income (AGI) allows them to take advantage of the special $25,000 passive loss deduction.

To learn more about reporting the sale of rental property, you can watch our on-demand webinar. NATP members can attend for free, depending on membership level! If you’re not an NATP member and want to learn more, join our completely free 30-day trial.