Small business owners who have set up a defined benefit plan for themselves and/or key employees may NOT be helping themselves out at all, especially if it comes in the form of a lump sum at retirement and is not structured inside a life insurance product.
Why? You may ask…
Medicare is now means tested.
Medicare is now using income in retirement to determine premiums for Parts B & D. Unfortunately defined benefit plans aren’t looking as attractive as they used to since the income will count against beneficiaries in the eyes of Medicare.
For example, a 55-year-old who retires from a credible health plan at age 65, enrolls in Medicare when eligible, plans to live until age 85, and earns under $85k a year in income (as defined by Medicare) can expect to incur over $199,180 in costs to just cover Part B & D premiums – source Healthview Services.
Notice, however, what happens if this person sells a property and jumps into a higher income bracket:
|Earnings||Basic Healthcare Costs||Difference|
|$85,000 – $107,000||$275, 819||38%|
|$107,000 – 160,000*||$293,738||97%|
*Once an income bracket is reached, there is significant red tape to revert back to a lower bracket. Many may remain at the highest level for the rest of their lives—even if total income eclipses a higher bracket for only one year.
- You married, divorced, or became widowed;
- You or your spouse stopped working or reduced your work hours;
- You or your spouse lost income-producing property due to a disaster or other event beyond your control;
- You or your spouse experienced a scheduled cessation, termination, or reorganization of an employer’s pension plan; or
- You or your spouse received a settlement from an employer or former employer because of the employer’s closure, bankruptcy, or reorganization.
Please note that Medicare defines income as the total of your adjusted gross income and tax-exempt interest income you may have. These are the amounts on lines 37 and 8b of IRS from 1040. Some examples of income are: wages, salaries, tips, taxable interest, certain dividends, business income, capital gains, and unemployment compensation, as well as annuities, Social Security payments and some pensions. This includes all gains and dividends from investments, no matter what they are. Even municipal bond dividends get added to total income.
What isn’t income? Distributions from Roth IRA’s and cash values inside permanent life insurance policies.
Perhaps it’s time to redefine defined benefit plans or those that do receive them must realize that there are more than just taxes to contend with.