Brent Henningson, CEO of Saber Pension & Actuarial Services, participated in a “Money Tree Investing” podcast hosted by Kirk Chisholm of Innovative Advisory Group. Brent and Kirk were kind enough to allow us to reprint a transcript of the podcast, which follows.
Kirk Chisholm: Welcome to this week’s episode of the Money Tree Investing podcast. My name is Kirk Chisholm, and I will be your host today. So, today we have Brent Henningson. How are you doing today, Brent?
Brent Henningson: I’m doing well.
Kirk Chisholm: Good. Well, this is an exciting show for all you listeners. This is another one of our tax loopholes of the rich episodes. These are episodes where we try to bring you some really cool and interesting stuff from the deep, dark bowels of the tax and financial industry, where really only the very, very wealthy one percent are able to take advantage of some of these, which is not necessarily the case all the time, but this is the type of people that typically invest in these strategies and we are bringing them to you so that you can do the same. So, we’re talking with Brent Henningson, who is the CEO of Saber Pension and Actuarial Services. Brent is a CPA, and he primarily works with defined benefit plans. So, how’s it going, Brent?
Brent Henningson: It’s going great, Kirk. I’m actually a TPA, which is a common misconception, but a third party administrator works, like you said, on defined benefit plans.
Kirk Chisholm: It’s not the first time I’ve made that mistake, and I’m sure other people are wondering the difference. But what’s the difference between a CPA and a TPA?
Brent Henningson: A CPA is somebody who obviously specializes in taxes. A TPA is third party administrator, and they generally help with employee benefit plans like health plans, 401(k) plans, and in my case, defined benefit plans. They do the compliance, the administrative pieces of those plans to ensure that the employer is dotting their I’s and crossing all their T’s.
Kirk Chisholm: So, you’re a third party administrator, so you primarily just focus on defined benefit plans. Is that all you do?
Brent Henningson: Yes, I exclusively focus on defined benefit plans. In some cases, if an employer has employees, they’ll couple the defined benefit with a 401(k) plan. If that’s the case, I’ll do sort of the umbrella work, making sure that the two plans interact and coordinate.
Kirk Chisholm: So, if you’re only doing defined benefit plans, maybe you could excuse the pun, define a defined benefit plan for us.
Brent Henningson: Absolutely. I’ll talk about it in the context of 401(k) [plans], because I think everyone’s familiar with those types of plans. So, when you have a 401(k), that’s a type of defined contribution plan. And the way that works is people put in money every year. And when they get to retirement age, they have a pot of money, but the amount is going to depend on how much money they’ve put in and what the market’s done. With a defined benefit plan. It’s actually the other way around, where you define the pot of money, essentially upfront. So, if somebody is 40, you would assign a target upfront and then every year you would have an actuary, somebody like me, who would calculate what contribution would be needed to attain that final goal.
Kirk Chisholm: So effectively, if I said, “Hey, I want to have $10 million in my defined benefit plan”, I could just define that and then contribute it?
Brent Henningson: Essentially, yes, [but] the limit right now is $2.9 million payable at [age] 62. But it’s pretty common for somebody to define that maximum and then work towards that goal.
Kirk Chisholm: This is pretty cool, and I kind of want to talk about the differences between the 401(k) and the defined benefit. So, the defined benefit, just for clarity, that’s what a pension, right?
Brent Henningson: Yes, that’s another name for it.
Kirk Chisholm: Okay. Because I know that if you look back, historically speaking, pensions were a big part of retirement. And when did that change? Like what caused some of those changes? Maybe you can kind of talk about that because I think people have heard of pensions, but a lot of people don’t have them anymore.
Brent Henningson: So, pensions started at the end of the eighteen hundreds, as we became more industrialized to reward employees, and they ramped up in the forties and fifties. Because of some abuse with employers, there was a lot of legislation around protecting employees with regards to pensions. And so, some of that started to unravel pensions in a way. In other words, unravel the demand for employers to want to put them in. But then there were other things that happened. We had the market crashes in 2000 and 2008. That required employers to put in an enormous amount of money all at once. We had accounting standards that made it a little more onerous to record and more expensive from the corporate profitability standpoint. And all of these factors created this gradual shift from defined benefit to 401(k) plans because they’re just a lot easier for employers to have.
Kirk Chisholm: So, if you kind of look at this now, the larger employers from what I can tell, are pretty much doing away with defined benefit plans. I know some of them are even trying to…was it FedEx the one that just stopped, I think, the other day? Who just said we’re no longer contributing to it? So, do you see it? Let’s go back to this step and let’s talk about the differences between the defined benefit and the 401(k). What are some of the major differences between the two plans?
Brent Henningson: I’d say there’s three major differences. The first one is and talking about it in the context of the small business, because that’s where I specialize. So, with a 401(k), if they have a profit sharing component, somebody can put in around $60,000 a year. It’s a good chunk of change. And for most people, that’s plenty of money to contribute. But you have this small percentage of the population where that’s not enough or they would like to contribute more. And that’s where a defined benefit plan can be a really great alternative because the limits for a defined benefit can be $100,000 to $250,000+ per year. And so, it’s an enormous opportunity to make a tax-deductible contribution. So that’s the first difference. The second difference is with a 401(k) or SEP or profit sharing, every year, the employer can decide whether they want to make a contribution or not. And so, there’s a lot of flexibility with that discretion. And for a small business owner, that can be obviously an important thing because profits can vary from year to year. With a defined benefit plan, it’s a little bit different. When you put in a defined benefit plan, every year, at least in most years, you’re going to be required to put in something. It’s not going to be necessarily a fixed amount. There’s going to be a range of possibilities or a contribution range that you can contribute. But it is more of a commitment in the sense that you’re not going to say in a given year, “Yeah, I don’t feel like contributing, so I’m not going to”. And then the third difference is with a 401(k), usually the accounts are individual accounts. And so, each participant’s account is tracked in its own account, whereas with a defined benefit, the assets are pooled and then the benefits are kept track of by somebody like me or a TPA.
Kirk Chisholm: So basically, if you had like a hundred people, they all have the same account, and it is all pooled together?
Brent Henningson: That’s right.
Kirk Chisholm: So, it sounds like the defined benefit plan is a good strategy for small business owners or people who are earning a good income. What are some typical industries where this plan might make sense?
Brent Henningson: It’s a pretty broad section of industry. The traditional users of defined benefit plans are the doctors, the dentists, and the attorneys. And so, there’s definitely a demand in those industries, mainly because they tend to [have] obviously a higher income, smaller businesses without too many employees. It just makes sense for somebody like that. When I started this business, one thing that actually surprised me is just the number of people who are nontraditional users of defined benefit plans where there’s a lot of interest. And what I mean by that is those in what I’ll call the digital space. So, people who are doing things like YouTube stars or food blogs, or maybe they’re doing Facebook ads or any kind of digital marketing. I have quite a few clients in that space, and they tend to be younger than what the traditional user is. A lot of them are in their thirties or early forties and the thought there is, even though they can’t contribute as much as they would be able to if they waited until they were 55 or 60, they know they’re in an industry where the profits are good now, an industry that changes quite a bit, and it can change pretty quickly. And so, the thought is if they’re doing really well now, they’re making $500,000 or $1 million right now, why not put it in $100,000 or $200,000 today and continue doing that for 5 to 10 years and kind of take advantage of that tax savings?
Kirk Chisholm: That’s great. I know we have a lot of people from the health service sector listening to this show, so I’ve seen certainly a lot of interest over time to do that. But in regard to a plan like this, is it similar to like a 401(k) where you can just invest it in anything? Or what are some limitations? Or how should people look at that part of it?
Brent Henningson: There’s a lot of flexibility in what kind of investments someone can contribute or sort of invest the contributions into. Obviously, any marketable securities like stocks, bonds, ETFs, mutual funds, those are all fine. There are alternatives like real estate, more exotic things like art. Some of the limitations around those alternatives, though, is if somebody has employees, they need to make sure that they’re investing those assets in a way that they’re being a fiduciary and they’re doing it in the best interest of the participants. So, for example, somebody had invested in a beach house in San Diego or something like that, and then as the owner of the company and the Trustee of those assets was using that property for family vacations. That wouldn’t be acceptable because it wouldn’t be in the best interest of the plan participants.
Kirk Chisholm: All right, so the owner of the company can’t go buy a sailboat and sail around the world on the employee pensions. Is that what you’re telling me?
Brent Henningson: Yes, exactly. Or buy some kind of art and then that art’s hanging on their wall at home and displayed to everybody. It has to be in the best interest of the plan participants.
Kirk Chisholm: What if they invite the plan participants over for like holidays and they had them to look at the art? Does that count?
Brent Henningson: That would be nice. But, yeah, probably not.
Kirk Chisholm: So, I don’t know if you have some examples that you’ve gone through. Obviously, no names, but just how this works and maybe some ways that people have been able to save a good amount of money.
Brent Henningson: One that comes to mind is a person who had a large payout of $5 million or $6 million, and they knew it was a one-time payment, and then there would be subsequent income earned, but it would be quite a bit less than that large amount. And this person was in their 60s, early 60s. Their spouse worked in the business, which is another kind of bonus because you can essentially double how much you can deduct. And so, for this particular person, we were able to say, based on your income, your spouse’s income, your age, that you’re close to retirement, and then based on the fact that you want to frontload contributions (put more in at the beginning with the idea of putting less in as you go), they were actually able to put in about $900,000into their defined benefit plan, between that and the 401(k). That was an example of a home run, where they needed a big deduction, there was no other retirement vehicle that could get them this size of deduction but a defined benefit plan provided that solution.
Kirk Chisholm: Wow. I thought it was much lower. So, basically, there’s no number limit per year. It’s really just dependent upon how old they are and information like that, correct?
Brent Henningson: Yes, and that would be an extreme example. It would be hard to get a contribution much larger than that. It’s all in the regulations and guidelines, but that would be, like I say, a home run with them close to retirement, their spouse is an employee, and they really want to frontload that contribution stream.
Kirk Chisholm: You know, not everybody is a one-person business. Some people might have small businesses. You mentioned dentists, doctors, attorneys, maybe architects, people like that. People make good money, but maybe have some employees. So, what are some rules that people can think about as they’re considering this type of thing for their business?
Brent Henningson: When you have employees, you’re required to cover them, or at least a portion of them under nondiscrimination regulations. And what those rules are for is making sure that if the owner is going to get a tax deduction, that they’re not just taking all the contributions and funneling it to themselves as the owner. So, they’re giving their employees something in exchange for that tax deduction. So, if they had employees, kind of a general rule of thumb is 8% to 10% of their staff payroll would be what it would cost them. As an example, if, let’s say they had a million dollars in payroll, it would cost them $80,000 to $100,000 in benefits. If they were able between them and their spouse, who could also be an employee, to save $250,000 or $300,000 in taxes, maybe that’s not such a big deal. So, it’s weighing the value of that tax deduction against the cost of providing those staff benefits.
Kirk Chisholm: It sounds like as a staff member, it would be nice to have this sort of plan. Are there ways that the employers can…do they have to offer this to everybody or are there certain caveats and carve-outs they can have so that it doesn’t have to be offered to every single employee?
Brent Henningson: So, if they’re not an employee, let’s say they’re an independent contractor, then they wouldn’t have to provide a benefit to them. And, obviously, they need to be a bona fide independent contractor to be excluded. If somebody is under 21, they also can be excluded. And then if they’re part-time, meaning they work fewer than a 1,000 hours per year, they also could be excluded. There’s also a carve-out if someone’s part of a collectively bargained agreements. So, there are opportunities for carve-outs, but for those who don’t fall in those categories, they generally are going to need to cover those or at least a portion of those people.
Kirk Chisholm: So, you mentioned spouse too. So how does that work? Can you get twice the benefit if a spouse works in the business?
Brent Henningson: If it’s [only an] owner and spouse, then definitely. If there are employees involved, then sometimes the spouse can be used to reduce those staff contributions. And what I mean by that is by giving this spouse a smaller benefit, it helps pass the nondiscrimination testing. So, it’s trying to get to the employer’s objective of how much they can save, and at the same time, trying to minimize that overall cost, as they need to provide something to their employees. It’s balancing a lot of different factors to get to that result.
Kirk Chisholm: In terms of the defined benefit plan, so when can people take funds from that?
Brent Henningson: When you establish a plan, there are rules around what’s called permanency. It sounds a lot more scary than [it is]. They don’t have to be in existence forever. But what the IRS is trying to avoid is somebody putting in a plan, taking a huge tax deduction, and then immediately terminating that plan a year later. They’re trying to avoid, obviously, someone creating some kind of a tax gimmick. And so generally, if someone keeps the plan three to five years, from the IRS’ perspective, that’s going to satisfy the permanency rule. Once that plan is established, funded, and then after that three to five year period, it can be terminated. Then those funds can be rolled over into an IRA or to some other qualified plan, like a 401(k), if it allows rollovers, and then you’ll then be subject to that plan receiving those funds. So, it would be subject to the IRA rules, for example, with the 59-1/2 [requirement].
Kirk Chisholm: This sounds great. If I wanted to set up a defined benefit plan, what would I have to do? I just go down to my local broker-dealer and just set one up. How does this work?
Brent Henningson: Defined benefit plans are really specialized. It’s a lot different than setting up, let’s say, a Solo K or a SEP…those things can obviously be done by the business owner on their own a lot of times. With a defined benefit plan, it requires that you have an enrolled actuary certify the figures, and I’m an enrolled actuary. So, they would need to contact somebody who specializes in defined benefit plans. Typically, the first step is talking about what they’re trying to achieve. How much are they trying to get into the plan? Do they have employees? How long is their horizon? And then from there, it’s putting together an illustration to show them what that would look like in hard numbers. And then if it makes sense, then it’s obviously going through the steps to adopt and fund the plan.
Kirk Chisholm: I spent half my career working in a broker-dealer world. I’ll tell you that there’s not a lot of talk about defined benefit plans. It’s not the thing that they teach you over there. There’s nothing wrong with that. They’re trying to help, but I find that most advisors aren’t even familiar with this. They don’t know how it works. They don’t know how to do it. It just seems like it’s really complex. There’s a lot of things that we talk about on the show that you probably never have heard of. And part of the reason is the fact that a lot of advisors just don’t know. They’ve heard of pensions. They’ve heard defined benefit cash balance plans. They’ve heard of all these things, but they’re not really familiar for many different reasons. So, if your advisor is not familiar with this, look around and talk to other TPAs like Brent that can probably help you with this, because I know I’ve learned a ton from working with Brent with plans that we do, and he’s extremely knowledgeable in the fact that this is the only type of business that he does. You’re an actuary was that take a week to get that?
Brent Henningson: I started working on these types of plans in 2001, and I got my actuarial credentials in 2008. So, for me, it took seven years. That’s kind of on the fast-end of the spectrum for somebody to be what’s called a Fellow of the Society of Actuaries. So, obviously, a lot of work, a big commitment, and there’s a lot of work that goes into understanding how these plans operate.
Kirk Chisholm: I say that in jest because I know how hard it is to be an actuary and pass [those tests]. I’ve had a few people try to explain it to me. And I was like, “Why would people ever want to go through that? That just sounds painful.” So, this has been awesome. I’m glad to have you on the show. I’m glad we’re able to share your knowledge with a lot of people here as listeners, because I know this is one of those tax loopholes of the rich that I really want to kind of get the word out there about, you know, we’ve had a few people on the past talk about some other ones and we’ll have some others on the future. But for people really high income earners that are looking to put money away for retirement, this is a really interesting vehicle to explore as a way to exceed the 401(k) limits that most of us have with our annual contributions. Any final thoughts on those things we haven’t talked about, Brent, you think we should know?
Brent Henningson: I think you hit it right on the head a second ago [about] when does it make sense to explore this type of plan? To keep it really simple, I would say that if you’re being limited by your current retirement plan in the sense of how much you can put in. So, if you want to put in more than the $60,000 that a SEP or 401(k) allows, if your compensation is such that there’s a compensation limit that’s coming into play, if you’re being limited for any reason on those type of plans, that’s where it’s at least worth asking the question if this plan makes sense for you.
Kirk Chisholm: Great. Well, Brent, I really appreciate you coming on the show here and sharing the knowledge with our listeners. And where can people find more about you?
Brent Henningson: They can go to my website, which is saberpension.com. It has a pension calculator where people can figure out how much they could contribute per year. There are case studies, so there’s a lot of good information on there.
Kirk Chisholm: Well, thanks for coming on. The show will certainly put a lot of this information in the show notes, so people can learn more about this really interesting topic. Thanks again for coming on the show, Brent.
Brent Henningson: Thanks, Kirk. I appreciate you having me.
Kirk Chisholm: Wow, that was a great interview with Brent Henningson, and I’m really glad we had him on the show, because I know Brent’s a real expert in this area and I’m always leaning on him for his expertise when I come across this in my practice.
©2019, Saber Pension & Actuarial Services, LLC. Used with permission. Note that the transcript reflects minor edits for readability purposes. The recorded podcast can be found on Spotify, here.
Brent Henningson, FSA, EA, is the CEO of Saber Pension & Actuarial Services in Gilbert, AZ.
Kirk Chisholm is a Wealth Manager and Principal at Innovative Advisory Group, where he is co-chair of the Investment Committee and Head of the Traditional Investment Risk Management Group. His background and areas of focus are portfolio management and investment analysis in both the traditional and alternative investment markets.
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