Armando (0:00 – 0:57)
Hello, founder. You’ve built a successful business. Now it’s time to come in here with Axiom Founders Family Office in Arizona.
You’re going to have a great conversation today with Henry DeSpain of MGKS, one of the largest actuarial third-party administrative firms in Arizona. And I’ve known Henry for a very, very long time and worked with him in a lot of different situations. And the conversation we’re going to have today is really focused on that that exit of the business.
And his expertise is all in the retirement plan space. He’ll speak to that, but it’s an area that is really, really specific. And I lean on Henry as my expert in that area, because Henry, you’ve always come through in terms of just having a team that has so much knowledge in that space, that if there’s a way to get something done, you’re able to figure it out.
So, Henry, I’ll ask you to introduce yourself if you don’t mind, please.
Henry (0:58 – 1:24)
Sure, you bet. My name is Henry DeSpain. Like Armando said, I am here at MGKS.
We’ve been in business for many, many years here in the Valley. We’ve got clients not only here, but all over the United States. That’s been our expertise, our bread and butter, is we’ve just focused on third-party administration.
We don’t do investments. We don’t do anything else. It’s just strictly administration.
Armando (1:24 – 3:11)
Yep, yep. And you’ve got a lot of people that are on staff to help spread the work out. And you’ve been doing this for a long time, so I know that you’re extremely knowledgeable in what you do.
So, Henry, we’ve had a variety of client situations with you over the years. And what I like about what you do is, your rules are pretty clear what you can and can’t do. This is governed by federal law, by ERISA.
And so, those federal rules, whether it’s Arizona, California, New York, doesn’t matter. It’s federal rules. But what I like about working with you is that we’ll give you a situation and tell you what we’re trying to accomplish, or really what that business owner is trying to accomplish.
And then we’ll have a conversation about it, see what might work, if anything, given the goals that business owner is trying to get to. So, one of the ones that I’ll ask if we can start with is, we had a client years ago who sold a business. And in talking with that business owner right after the sale, just the way it was structured, even though that business is already sold, a plan could be put in place, some type of qualified plan, a retirement plan could be put in place, that just had a very, very dramatic impact on deferring that tax bill, because it was a brand new deduction that was created, you know, after the sale of the business. So, maybe you could talk about, you know, that’s probably pretty extreme. Deal’s already done.
But, you know, it can be done. Maybe you can just touch on that if you could.
Henry (3:12 – 4:38)
Sure, yeah. It really comes down to, you know, is this an asset sale or is this a stock sale? And what I mean by that is that, you know, are you selling the assets of the company, but you’re still going to remain, you know, the quote-unquote owner of the corporation or owner of the business?
It’s just that you’re selling all of your goodwill and all of your products to someone else. And if that’s the case, and you still own the corporation after the sale, then there is a possibility of being able to sponsor a plan. And that’s the key, is that these retirement plans have to be sponsored by an entity, you know, by a corporation or a sole proprietor or a partnership of some sorts.
The great thing about it is that you, as long as you have that entity, and as long as there is some form of income coming into the entity that you want to defer, you know, usually we can devise a way to be able to accomplish that. And the example that you talked about, it was very simple, you know, in the sense that the buyout was occurring over several years. And so therefore, the company would be receiving income or payments for that buyout of the assets.
And so it was simply a matter of being able to devise a plan that would be able to absorb some of those dollars in the way of contributions and defer the tax on that income.
Armando (4:38 – 4:58)
Yeah, yeah. And that worked out really fantastic for that business owner. And so, Henry, maybe for someone who isn’t familiar with the types of retirement plans that are available to them when they own a business, maybe you could just touch on, you know, the high points of those plans in general, how they work, just at a very high level.
Henry (4:59 – 6:25)
You bet. Yeah, yeah, no, I’d be happy to. 401k profit sharing plans are probably the most basic types of plans out there that you see most companies have.
And what that means is that they allow for the individual to take money out of their paycheck and to put it in usually a tax deferred basis into the plan. That’s called the deferral piece, the 401k deferral. But in addition to that, they usually allow for some kind of either matching contribution or profit sharing contribution that the company can put into that plan as well.
So it’s kind of a partnership between the employees and the company, meaning that, you know, they’re both funding towards that individual’s retirement. The other more common plan that we see with small employers is a defined benefit plan. There’s variations from it as well.
But a defined benefit plan, I always try to explain is just like what grandpa had when he worked for Ford Motor Company and he worked there for 30 years. And when he retired, they gave him a gold watch and they gave him what was called a pension. Well, that pension was funded through this defined benefit plan.
And we can certainly use that defined benefit plan in a small business sense in order to be able to hopefully maximize retirement contributions and also tax deductions for an owner and for some of the employees.
Armando (6:27 – 6:55)
Yeah, I’m glad you brought that up because the pension plan that Ford can put in place for its people is based on federal law. And even though Ford may have thousands of employees for a one man shop or one woman shop company, they can use that same federal law and the same, you know, the same exercise basically to get a similar benefit, even though they only have one employee, which might be the owner themselves.
Henry (6:56 – 7:45)
Correct. Yeah, yeah. And the great thing about it is that, you know, whereas, you know, grandpa working at Ford Motor Company may have funded, you know, that plan may have been funded over a 30 year work history.
The great thing about it is, is that these defined benefit plans, if you’ve got an owner only situation, maybe someone that’s a little older, 55, 60, you know, can see the retirement horizon, so to speak, and know that, hey, I’ve just got a few more years, I need to kind of beef up my retirement benefits. Defined benefit plan is a great way to do that, because it will allow you to basically squeeze all those 30 years into say, a five, 10 year period where you can, you know, super max fund a retirement plan and catch up on some of those lost contributions.
Armando (7:46 – 8:17)
Yeah, it can be very, very, very, very powerful. Henry, let’s talk about a maybe a maybe a small partnership, where maybe a younger partner wants to buy out the older partner, your partner might not have a might not really have the money or the where the means to just buy that person out. How might a pension plan or retirement plan?
How might that help them accomplish that goal of the older one, selling to the younger one over a number of years?
Henry (8:18 – 9:44)
Sure. We’ve had a couple of situations in with just what you’re describing there, where, say that the younger partner, whether it be a family member or not, will will forego some of their profits annually from the company. But but those profits would go towards the funding of the the retiring partner, if you will, in the way of defined benefit contributions.
And then what happens is, is those foregone, you know, benefits that that younger partner has has given up and, for lack of a better term, turned over to, to the owner, the older owner, they can be offset in the old in the whole buyout situation. So, so that it’s obviously something that’s a little bit more advanced in planning. And I always recommend that you involve a, you know, a good attorney and that everyone understands what the ramifications are.
But it is something that works out very well, either on a partial basis or a full basis buyout, say, someone because the great thing about it is, is that, you know, the owner, the retiring partner can now take those funds and then have a little bit more control over when he recognizes them as income or in other words, when he’s taxed on them, as opposed to having to recognize them in the year that the payment is made.
Armando (9:45 – 10:11)
Yeah. Yeah. So it’s, it certainly is an option.
And, you know, you mentioned, you know, bring in an attorney, an ERISA attorney who really understands the space, because these can get very complex, can be very, very powerful tools, but can be misused or misapplied if not done correctly. And that attorney can be critical to make sure that, that all the I’s are dotted and T’s are crossed so that it’s good from day one.
Henry (10:12 – 10:14)
Definitely. Yeah, I agree.
Armando (10:14 – 10:37)
Yeah. Okay. Would, would, uh, if there’s a management team in place, Henry, that maybe wanted to buy out that owner, you know, there’s a tool called an ESOP, Employee Stock Ownership Plan, but could a retirement plan be used for that purpose as well, possibly to buy out?
Henry (10:38 – 11:23)
Yeah, no, definitely. You could, you could do that type of an arrangement where you had an ESOP, but, but you could also do it, you know, like I say, through, uh, um, through the defined benefit or, or through the, say the 401k profit sharing. ESOP is probably a more traditional way or, or the, or the most common way that people have seen that happen.
Uh, the, the one issue that, that comes up though, is, is that with small employers, it’s a little bit difficult to manage from the standpoint that ESOP is going to be very expensive. Uh, there’s, you know, a lot of requirements, a lot of hurdles to jump over and, and the valuations that have to be done with regards to the company and to the, to the stock itself kind of outpriced a small employer from, from going that route.
Armando (11:24 – 11:43)
So if they don’t go that ESOP route, and let’s say there’s a management team that wants to buy out the owner and say there are three or four people who, who will be the new owners once the old, once the existing owner is out, they could possibly use a retirement plan, some kind of a structure there to help that buyout take place.
Henry (11:44 – 12:29)
Yeah. Yeah. Most definitely.
Uh, uh, and, and again, you know, it’s just a matter of coming up with an agreement that everyone is willing to live by. And just to give you a quick example, that could be something as simple as saying, Hey, we’re, we’re going to contribute out of our profits, you know, the, the management team’s profits, $100,000 each year to go towards the buyout, but that $100,000 will go as a contribution to the defined benefit plan for the individual being bought out. And therefore, you know, after two, three, four years, depending upon what the agreement may be set up, you’ve got a nice chunk of change there that you can use to offset the buyout or, or to use as a total buyout.
Armando (12:30 – 12:46)
Yeah. Yeah. So if the management team doesn’t have the financial means to just write a big check to buy the, buy the person out, it sounds like something could be structured, or at least it’s worth looking into to see if it could be structured, that some kind of a plan like this might work.
Henry (12:47 – 13:25)
Definitely. Yeah. Yeah.
And the great thing about, uh, uh, retirement plans, like you had mentioned earlier, uh, Raimondo is that, that, that they, they run the gamut, meaning that they can be a very simple setup where it is a, you know, a 401k plan that allows employees to defer into the plan, or they can become a very exotic design where, you know, you’re looking to try to purchase out to someone from, from their ownership in the retirement plan, or like you mentioned at the company for, uh, uh, for a period of years.
Armando (13:27 – 14:40)
Okay. Okay. So we, I know we’ve talked before too, about maybe there’s someone who retires early and if they retire early, they probably don’t really need additional income.
That’s how they were able to retire early, but then often an executive will go and serve on a board of directors and they might do that for 10 or 15 or 20 years after they retire. And often as, as we’ve seen that individual then gets 1099 income, not a W-2, but 1099 income. And with that income, that ongoing revenue coming from that board service, they in effect have their own business with its own revenue and they can use some type of plan and put away some big chunks of money as well.
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Henry (14:41 – 15:06)
Definitely. Yeah. And we’ve seen this type of a structure before several times where they may be on a board of directors or several board of directors and that income, like you mentioned, is not necessarily needed.
They can defer some or a majority of that income into a retirement plan and defer it until a later date. And it works out pretty great for their particular situation.
Armando (15:08 – 15:55)
Okay. Yeah. It can be really fantastic in the right situation.
So, Henry, if someone is planning to sell their business and somehow exit that business in the next five years, and as many people begin to look at their retirement, they want to have that nest egg to have more in it and they feel a little behind. So, obviously selling the business is going to be big payday for the business owner. But one of the things that is a big advantage of most retirement plans, if not all of them, is the tax advantages that money that goes into that vehicle is not taxed.
Can you touch on that a bit?
Henry (15:56 – 16:54)
Sure. And that’s something that is sometimes misunderstood, not only from the business owner’s point of view, but from some accountants as well, is that the contributions that go into a retirement plan are a dollar for dollar offset on your income. In other words, if you have $200,000 in income and you’re able to put $150,000 into a retirement plan, well, that leaves you with only $50,000 in taxable income for the year.
And so, it’s a great way to be able to save on taxes with regards to that type of strategy. It’s one of the last few pure tax savings that you can actually do within a company. The great thing about it is that then once that money is in the retirement plan, it’s there, it’s for you for retirement, and then you can structure how you want to withdraw it at retirement.
Armando (16:55 – 17:54)
Yep, to be very impactful. Yeah, very, very impactful. So, we talked about a retirement plan, qualified plan being used as a way for management to buy out an owner.
We talked about maybe two partners being able to use a plan to buy, one to buy the other one out. And the plans, of course, as you said, it can be pretty complex. And you’ve got to really dig in and look at the structure, look at the owners, look at the employees and that.
What is involved in that process for you to be able to tell an owner whether they can use that strategy or not to help them with their own transition out of the business? What do you need from them? And how does that process work?
Henry (17:55 – 19:22)
Usually, what will happen is that we will have either a sit down meeting or a phone conversation, and that meeting can take usually about 15 to 30 minutes. And it’s really just kind of a discovery process. We’re trying to understand, okay, well, what kind of a buyout is it?
Again, is it an asset sale? Is it a stock sale? How long will the buyout be structured?
Will it be a one time payment? Will it be over several years with the down payment? And just understanding the overall structure of how that would go down.
Once we have that understanding, we can go back to the office, run a few scenarios of, hey, here’s what kind of possibilities would result from the situation that you’re in. And again, different situations cause us to use different kinds of designs and different kinds of ways of being able to defer that, along with obviously what the desired savings for the individual is. Some may think that $50,000 a year is great, and that’s all we’re looking to save.
Some may say, hey, I would like to do as much as possible. And with defined benefit plans, potentially you can get 250, 300, even 350,000 or more in contributions per year, which is a huge tax savings when it’s time to pay taxes.
Armando (19:23 – 19:50)
Right, right. Yeah, we had an older gentleman last year who has a cash balance plan, and he put away half a million dollars, significant. Of course, he’s older, so he was able to do that because of the actuarial tables that IRS uses.
And maybe you can touch on that, Henry, how does that work? Older person versus younger person, why does that matter?
Henry (19:51 – 21:03)
Yeah, no, that’s a great question. And it is a little complex, but the bottom line is that the IRS looks at it from a retirement age perspective, meaning let’s just, for example, take a retirement age of 65. And for someone who is age 60, well, the IRS says, hey, you have a very short timeframe.
You’ve only got five years to retire. So because of that, we will let you put in a lot more than, say, someone who is 30 and therefore has 35 years to retirement. So the IRS places a limit on how much you can have in, say, a defined benefit plan at age 65.
And it’s just a matter of time. In other words, if you’ve only got five or 10 years to fund, you’re going to be able to do larger contributions to meet that deadline, so to speak. Whereas, say, someone who’s 30 years old has a lot of time, and so therefore the IRS has smaller contributions in mind for you over that time period.
It goes back to the whole present value, future value discussion that you learned, hopefully, in college at one point.
Armando (21:04 – 21:34)
Yeah. Yeah. I think now the calculators do all that stuff for us.
The present value on that. And so let’s talk about the income too, because the type of income the person receives, I mean, the individual, the type of income that person receives from the company also has an effect on how much the person can put into some type of a plan, correct?
Henry (21:35 – 22:36)
Correct. Yeah. So these, with regards to, say, a defined benefit plan, these plans are structured based upon what your salary or your income would be.
The higher the salary, obviously, the higher contributions you’re able to put into the plan. If an individual, say, may have been taking a lower salary, and when I say lower, I say, say, $75,000 to $100,000 in the past, we would require that they take, say, $200,000 or maybe $250,000 so that we can beef up that salary average. The IRS allows us to use a three-year consecutive average for determining contributions.
So if you came to us and you said, hey, you mentioned with Armando that I can get $350,000. Well, my response to you will be, yes, you can. What’s been your salary history?
And maybe you need to start taking more in salary to be able to meet that goal.
Armando (22:37 – 23:40)
Yeah. And that’s where the planning, really, your planning with them is critical. At the same time, in my seat, when we’re helping them plan for that individual and that family, there’s a balancing act between the more income they get that’s taxable that allows you to help them put a bigger contribution into that plan, then that means more taxable income.
But it also means they can deduct more and put more in the plan. But there’s a lot that really goes into where is that sweet spot for them to understand how does it work? Because there’s the business impact, the impact on the family, and then what is the long-term plan for the company?
If they really want to sell this company, say, in five years, maybe they have to, as part of that exit, maybe they really have to heavily fund this as much as possible so that they can have that exit in five years for whatever reason.
Henry (23:41 – 24:32)
Definitely. Yeah. And you bring up a great point because we realize that our role is really kind of a narrow slice of the pie.
Obviously, you’ve got the full picture or their advisor would have the full picture of what’s going on. And there are other pieces there. Obviously, family matters, insurance, estate planning, all those things go into, obviously, the overall planning process.
And we realize that our small piece, even though we may say, hey, look at all this money we can save you, may not make necessarily very good sense or a very good strategy for the overall planning process. So while we could get you $350,000 in a deduction, maybe it makes better sense for you to take only a $200,000 deduction. Right.
Armando (24:33 – 24:49)
Right. And that’s part of what I like about the plans as well, Henry, that there’s a range, not a definite yes or no and a definite flat dollar amount. It’s more of a range, given what is that business owner really trying to accomplish.
Henry (24:51 – 26:11)
Definitely. And that’s part of that overall planning process that we talked about just a little bit before this is that we will certainly kind of come back to the office, run some scenarios. But our first pass is always kind of a maximum scenario, meaning that we’ll look at it and we’ll say, hey, this is how much we can get you.
But now let’s sit down with you. Let’s sit down with your advisors. Let’s discuss what is reality, what works for you, what makes the most sense with regards to those deductions.
And knowing also that with a small owner, it could be that $200,000 works this year, but only $100,000 works the next year or $100,000 works this year and $300,000 works next year. The good thing about these retirement plans is we have the flexibility to be able to somewhat control those. But the big thing is planning.
So I always stress that is that if you plan in advance, we can pretty much accomplish what your goals are. Just don’t come to us in arrears and say, hey, can you make this work? That’s unfortunately doesn’t work for us.
And really it goes back to those IRS rules. They allow us to future plan, but they don’t allow us to do damage control after the fact. If that makes sense.
Armando (26:11 – 26:16)
Planning ahead of time is often the best way to go in despite anything, right?
Henry (26:17 – 26:17)
Definitely.
Armando (26:19 – 26:44)
So when you’re having that initial conversation, we had a new client in recently who started a plan not too long ago, just very, very recently as well, maybe two years ago. And he was astounded at what he could do, how much he could put in. When you’re having those initial conversations with the business owner and showing them the numbers, what they can do, what are some of the surprises or the ahas that you hear from them?
Henry (26:45 – 29:12)
I think that the biggest surprise is that what we just spoke about is that we can certainly control these contributions with some planning in mind. And so in other words, we might come to them and say, hey, look, here’s your maximum contribution. It’s $300,000.
And they say, that’s wonderful, but I also need to pay my rent and my mortgage and put my kids through college and all that stuff. And so we can say, well, great, let’s tone it down. Let’s do $150,000.
And then if there’s ever a year where it’s a boom year for you and you have extra dollars, great. We can certainly plan a way for you to be able to shelter extra income in the future. The one, I guess, negative or aha moment is also kind of what I talked about is that this is all, like I say, based upon IRS rules and regulations.
And so therefore, what they say is once you start down this path in any given year, if you’re too far into the year, they won’t allow you to change that. Meaning that if you’ve committed to $100,000 and now you’re coming to me in November and saying, oh, I can’t do $100,000, that becomes an issue with regards to the plan and with regards to the IRS. And so the pre-planning, determining how much you’re comfortable with is a big factor in that.
And so while you may say, okay, I want to do 300,000, but your advisors are saying, don’t stretch yourself. Maybe you should do only do 200,000 or 150,000. We totally agree with.
It needs to be something that is comfortable for you to accomplish in any given year. And the great thing about it is that the IRS will always allow you to usually to do more. So in other words, if we target say $100,000 and then now we get to the end of the year and you realize, hey, I can do 200, well, we’re able to be able to make adjustments and to be able to accomplish that goal for you, given that you’ve taken enough salary and that we’ve got other things in place.
So coming back with needing to do more, it’s always an easy thing to accomplish. Coming back and saying, I can’t meet that goal, it becomes a problem towards the end of the year.
Armando (29:13 – 29:43)
So it also sounds like if the retirement plan is being used as part of a buyout, then if you have a lot of profits in the business one year, you might be able to pay down or buy out a little faster. And if you have a year where there aren’t the profits there that you want to have, that you’re not necessarily required to make that big hefty contribution or payout to the other owner. There’s some flexibility there for that, right?
Henry (29:43 – 29:47)
Definitely. Yeah, yeah, definitely. There is some flexibility there.
Armando (29:47 – 30:05)
Mm-hmm. Okay. Okay.
So cash balance plans and defined benefit plans, I hear those terms being used, both terms being used, and what are they? Are they the same thing?
Henry (30:06 – 32:35)
They are the same thing. Really all a cash balance plan is, it’s just a different spin on what a defined benefit plan is. So again, a defined benefit plan is like what grandpa had with Ford Motor Company.
But what a cash balance plan allows you to do, and the IRS has blessed this and come out with appropriate regulations and stuff, is that they allow you to present it in the format that is a little bit easier to understand. Without getting too technical, I’ll just kind of give you a quick example. A defined benefit plan usually structures benefits around a theoretical annuity of retirement.
So in other words, you may be working for a goal of achieving $4,000 a month at retirement. That’s your goal to fund for and to achieve under a defined benefit plan. If you came to me and said, well, okay, well, great.
What does that mean in today’s dollars? That’s a little bit more difficult to explain or to understand. And what a cash balance plan has done is kind of overcome that obstacle and said, hey, instead of determining the benefit at retirement as $4,000 a month, we’re going to determine it as an account value as of today.
And so they may say, hey, you know what? Yes, we’re targeting $4,000 a month at retirement. But as of 12-31-2022, your account balance under this method is $2,000 or whatever the number may be.
So that way you see, oh, okay, hey, I have this account balance as of this date that is equal to $2,000. And I know that as of next year, at the end of the year, I’ll get another statement that will show what kind of contributions went into the plan and what my balance is as the end of that year. So that my balance may be $5,000 or whatever the number might be.
So think of cash balance plan as really just a nice way to be able to explain a defined benefit plan. It gives you a nice summary account balance, almost like your bank statement that shows you, hey, here’s what your beginning balance is. Here’s what your earnings and what your contributions are for the year.
And here’s what your ending balance is.
Armando (32:35 – 32:45)
Okay. And so is it showing that to owners? Is it easier for them to understand and make decisions on how much they should contribute in that?
Henry (32:46 – 33:22)
Yeah, definitely it does. To be able to show someone, hey, if you put away $100,000 a year, that’s going to give you a $4,000 monthly benefit. That’s a little bit tougher concept to grasp than to say, hey, if you put in $100,000 as of today, well, then next year when you put in another $100,000, your account balance is going to be $200,000 plus whatever earnings may have been on those assets.
So that’s an easier concept to be able to realize and to understand.
Armando (33:23 – 33:53)
Hmm. Henry, at what point, you know, you’ve worked with lots of companies, obviously. At what point does the company have enough, is there a certain profile of the company size, you know, numbers of employees, numbers of revenues, profits, been in existence X number of years?
Is there a certain profile of that business where that’s when they should talk with you about some of these options?
Henry (33:54 – 35:24)
You know, there’s no magical number, but I would definitely say my experience has been that if you find yourself in the neighborhood of $50,000 to $100,000 in income that you feel you could, you know, live without and would like not to be taxed on it for the year, then that’s probably a conversation, you know, that we should sit down and look at and see what the possibilities are. You know, obviously anything greater than that also works, but it seems to me that usually between 50 and 100 is kind of a benchmark there. And again, I would say to make sure that that’s comfortable for you.
In other words, you’re not stretching to be able to hit that mark, but you feel like, hey, if $100,000 was not there in the business and I was not going to receive it as income, or it was not going to be used to build the business, would I miss it? And if the answer is no, then yeah, we should take a look at it and have a conversation about doing a retirement plan. Because again, you know, as an example, if you were say in the anywhere from the 35 to 40% tax bracket, which I think a lot of business owners are that are somewhat successful, $100,000 contribution means that you’ve just deferred taxes on that $100,000.
And therefore you save yourself 35 to $40,000 in potential tax savings.
Armando (35:25 – 35:58)
Right, right. And just so it’s clear, the tax savings would be this year when that, I guess in that in the year of that tax return for that business, which most businesses now are calendar versus fiscal, but it’s going to be the tax savings on income tax that year for the, you know, for the, the, the business owner. But it’s on the purse level, it’s deferred.
So when they pull the money out later, that’s when they’ll pay tax on it, just like an IRA. Right? Same idea?
Henry (35:58 – 37:03)
Correct. Yeah, exactly. So, so while the while that $100,000 contribution is a deduction for the company, that they that the company would have to pay taxes on and or pay, you know, the owner of salary on the back end, when the individual decides that they need to start drawing money off of that, well, that’s taxed to them on a personal basis.
And the thing to keep in mind is, is that, you know, hopefully what we have there is a situation where their distributions that they take at retirement will be something, you know, less than what they were taxed while they were working. So while, you know, you may be in the 35 to 40% tax bracket during your working life, potentially, after 65, and you’ve retired, your your retirement tax bracket may be 25 to 30%. So you save some taxes that way, plus you’ve been able to tax, you know, you’ve been able to defer those dollars, and any earnings on those dollars during the time that it’s been in the retirement plan.
Armando (37:04 – 37:19)
Right, right. So a lot of flexibility, I suppose something’s really inflexible, but there is flexibility within that it’s worth a company owner, at least having a conversation with you to see what you know, what might work for them.
Henry (37:20 – 37:51)
Yeah, yeah, definitely. And we’ve always been willing to sit down with anyone that’s interested in pursuing, you know, what possibilities are there, we don’t ever charge for our analysis upfront. It’s just if you decided to actually set up a plan that there is a charge.
So yeah, someone can certainly come to us and say, hey, here’s my situation. What does it look like? Does it make sense for me?
And we’re happy to run a few scenarios so that you can understand, you know, what possibilities are out there for you.
Armando (37:51 – 38:36)
Yeah. So what about, Henry, some people will sell their businesses and they’ll carry a note, they’ll get paid over three years, five years, they’ll in effect just carry a note. And, you know, an installment sale is another way to say that you’re going to get your remaining payout over time.
Is that maybe an opportunity when they’re carrying a note, there’s an installment sale, is that maybe an opportunity where a plan, maybe they should think about a plan or maybe have a conversation with you because that might, a plan being put in place at that point might make sense for them?
Henry (38:36 – 39:24)
Yeah, I would agree with you. I think definitely that’s a potential there to be able to do a plan. And again, knowing that there’s a lot of other circumstances that come into play there with regards to that type of a scenario.
It may be that you’re not using all of the money towards a retirement plan and maybe that you’re just using part of it. But any type of installment sale or a note carried forward, we see that a lot in businesses where the sale is to say, you know, we’re going to give you a lump sum and then installments over two, three, four years. And those are really kind of the best situations for us as far as being able to plan out a retirement plan or a retirement scenario that would be able to shelter some of that income that they’re receiving.
Armando (39:26 – 39:56)
Okay. All right. And you said that, you know, some of the ahas are the tax savings and that they have some level of control of what they can put in from one year to the next.
Are there surprises or, you know, if a business owner is hearing this conversation, and maybe a little bit interested or intrigued about just where the conversation has gone? Anything that we haven’t touched on Henry that we should touch on?
Henry (39:57 – 40:59)
I think probably the biggest thing to remember is that these are retirement plans, and that they are used for retirement, meaning that that, you know, if you decide or commit to go down this road of establishing a retirement plan, the dollars that you put in the IRS looks at that as being used for your retirement. So, so in other words, once it’s gone into that pot, say, you know, retirement account, then it really needs to stay there. I mean, obviously, you can certainly terminate the plan and pull the money out and use it if you if you should need to.
But the problem with that is, is that you lose all of that that tax strategy that we’ve gone into planning out the plan and making it all work for you. So you’ve got those deductions with regards to the company. So I would say anything that you put inside the retirement plan, you know, plan on not spending it until you actually do retire.
[Speaker 3] (41:00 – 41:01)
Yeah, yeah.
Armando (41:02 – 41:28)
And that’s a good point. But, but it can be tempting if a business owner sees that account growing, and it’s it’s a pool of money. It is earmarked for retirement.
That’s what these plans are for. So there’s money there when you retire. But yes, I can see how you’re saying that they’ve got to remember that is what that’s for, and not be tempted to use it for something else.
Henry (41:29 – 41:30)
Definitely. Yeah.
Armando (41:32 – 42:08)
Okay. And so when a plan is set up, so someone can come to you and say, Henry, here’s what I’m thinking. And you know, can we do this and you can run numbers and see what does or does not work, have some conversation with them.
When they set up a plan, let’s say that somebody wanted to set a plan for this calendar year. And it’s the middle of the year right now as we’re having this conversation. If they wanted to have a plan for this calendar year, when do they have to make that decision so that it will be in effect for this calendar year?
Henry (42:09 – 42:44)
You know, that’s one of the good things that has recently come out with regards to retirement plans is that a couple of years ago, the laws were changed, and they will now allow you to set up a retirement plan up to the date that you file the tax return for your company. So, you know, again, if you wanted to set something up for 2022, technically, you have until the date that you file your taxes on your company for 2022, which could be, you know, March 15th, April 15th, or all the way through to potentially September 15th.
Armando (42:44 – 43:23)
Wow. Wow. So that is an incredible change they made when they made that.
Because from a planning perspective, it gives the business owner time to really look at those financials, those profits, which often take months to get done after the year ends. And they can make some decisions after the fact that really impact that year, the financials of that year. Definitely.
Do they have cash for that or not? That sounds like a really fantastic planning tool.
Henry (43:24 – 43:53)
Yeah, it definitely is. And as an example, I mean, here we are at the beginning of July, doing this meeting right now. And I just finished up a proposal for someone that was considering doing a plan for 2021.
They haven’t filed their tax returns. They’re on extension. They’re thinking of being able to try to get some kind of a tax deduction.
So the accountant reached out to me and I’m running some numbers to see what potentially could be done for 2021.
Armando (43:54 – 44:00)
Wow. Wow. And that wasn’t even possible a couple of years ago, right?
Two or three years ago? Right.
Henry (44:01 – 44:14)
Yeah. But before the deadline was end of the year. So if you didn’t have a plan in place by December 31st, 2021, you could not have a plan for 21.
We would be talking about 22 at that point. Yeah.
Armando (44:17 – 44:30)
That’s amazing. I’m surprised. So, you know, people complain about tax laws and changes and, you know, negative, negative, negative.
It’s putting more restriction. They’re terrible. This sounds like a pretty darn nice tax change that went into effect.
Henry (44:31 – 44:37)
Yeah, I would agree with you. This was one of the positive ones that came out of there recently. So it’s a good thing.
Armando (44:38 – 44:57)
That is a good thing. Henry, anything else that we should touch on when you think about your space, the comments you hear from the clients that you’re working with, you know, maybe when it’s a brand new plan, they’re asking all those very innocent, naive questions, things that we haven’t touched on.
Henry (44:58 – 46:05)
You know, the only other thing that I would probably add to what we’ve already talked about, Armando, is that, you know, like with anything else, a retirement plan is something new and different for you as a company owner and as the company. So I would say the biggest thing is to be patient with it because there are some changes that obviously have to take place with regards to your company, how you save, the administration of the plan. Our goal is to make that as easy as possible, but it’s important to remember that there are things that you would have to deal with.
You know, the retirement plan has its own tax filing that has to be done by October 15th of each year. You know, obviously there are accounts that have to be set up for the retirement plan and different things of that nature that require a little bit of attention. And that’s why I say, you know, the first year just kind of come accustomed and familiar with the plan, and after that it’s usually some pretty smooth sailing for you.
Armando (46:06 – 46:17)
Yeah, and there is maintenance that you have to do, like you said, the annual tax filing on that. You’ve got to run actuarial numbers based on the employee census, etc., correct?
Henry (46:18 – 46:57)
Correct, yeah. So there’s several tests and regulations that we have to meet or thresholds that we have to meet with regards to these plans. And so every year we do have to run different tests to make sure that the plan is compliant.
Excuse me. So we do have to go through and collect census information, plug that into our system, run the different tests, make sure that everything is compliant, fill out what’s called the 5500, that’s the tax form that goes with the plan. And then obviously the owner has to sign off on the 5500 before sending it to the IRS.
Armando (46:58 – 47:09)
Right, right. And they’ve got to, yeah, right, they’ve got to make sure to follow the rules to make it work. But that’s what you help them navigate, correct?
Henry (47:09 – 47:37)
Right, yeah, that’s obviously our responsibility and something that we help you do is to navigate that path that you have to go through and complete the forms so that you’re ready to send them in. I usually tell our clients, think of us as the CPA for the retirement plan, meaning that our job is to keep everything compliant, make sure all the tax filings are done, make sure that things are done timely.
Armando (47:38 – 48:30)
Right, right. Well, Henry, this has been very interesting, just hearing how flexible these plans are in the context of that, you know, that owner trying to sell. That’s another area where, you know, the space that you work in really could be useful for them.
As we talked about one partner maybe wanting to buy out another, maybe a management team wanting to buy out the owner. So different ways, or maybe they’ve already sold, now they’re going to get payments over time where a plan like this or a plan could be implemented because they’ve got that ongoing stream of income for a set number of years and a plan could be put in place where that money can go into the plan and therefore not be taxed, whereas it would be taxed if they just received the money in their hands.
Henry (48:31 – 48:58)
Correct, yeah, and you know, we see all types of different situations and scenarios, and so if you, you know, like we had talked about before, if you find that you have some extra income that you don’t want to be taxed on, that you would like to defer to retirement, you know, give us a call, we can walk through the scenario, we can see if something does or doesn’t work, and certainly plan from there.
Armando (48:58 – 49:49)
Okay, and Henry, just a couple last questions for you. When a business owner does sell, let’s say they have a plan in place that you’ve helped them set up, you’ve helped to maintain over the years, and now they’re selling that company to somebody else. You know, with most smaller business owners, that plan has a trustee and that trustee is going to be the owner of the business quite often.
So when that owner does sell that company to somebody else, and the company has a 401k or profit sharing or a cash balance or defined benefit plan, that plan could continue or it could get shut down. It just depends on what the owner, I mean, the owner of the business who is selling and the buyer, what they agree they want to see happen.
Henry (49:50 – 50:22)
Correct. Yeah, yeah, definitely. And, you know, we’ve seen, you know, many different scenarios play out that way.
Meaning that, you know, a plan could terminate, it could actually merge with the with the acquiring company’s plan. It could go with with the selling owner, you know, and remain with him or her as their plan and with their company. So there’s many different scenarios that could actually take place there.
And we’ve seen pretty much all of them.
Armando (50:22 – 50:37)
Okay, good. Well, good. I guess that would be another negotiation tool or bargaining chip when they’re at the table negotiating how that company’s going to transfer from the seller to the buyer.
Henry (50:38 – 50:39)
Most definitely.
Armando (50:39 – 50:54)
Yeah. Okay, great. Well, Henry, if someone has listened and to this conversation that we’re having, and they’ve got questions and thoughts about their own company, their own business, and they want to get ahold of you, what’s the best way for them to reach you?
Henry (50:55 – 51:20)
You know, there’s several different ways. Obviously, you can just go to our website, that’s mgks.com. And you can find us there.
Another way would just be to reach out by phone. You can call our offices here. It’s 602-944-1515.
Ask for myself or one of my partners and we’re happy to have a conversation with you.
Armando (51:20 – 51:28)
Okay, great. So that number again is 602-944-1515. Correct?
[Speaker 3] (51:28 – 51:29)
Correct.
Armando (51:29 – 52:15)
Okay. And you said or your website mgks.com. But if somebody wants to pick up the phone, they can just call, ask for you, Henry DeSpain.
Again, 602-944-1515. Henry, this has been very, very helpful. Thank you so much for the conversation.
Hopefully that business owner who’s, as you said, got extra cash, got profits, and would like to put some money away in your return plan, hopefully they will reach out and have a conversation with you to just see what that possibility might look like. And if they talk with you, Henry, and maybe it’s maybe they’re really not in a place for that now. I’m sure you would tell them that, but they could come see you a year later if they’re in a better or different position, right?
Henry (52:16 – 52:33)
You bet. Yeah. And I’ve actually said that to people before where I say, hey, it doesn’t look like things work right now because of X, Y, Z, whatever reason it may be.
But come see me in a couple of years and we can run a scenario again and look to see if the results are better.
Armando (52:33 – 52:56)
Yeah. And that’s part of what I’ve enjoyed about having the working relationship with you, Henry, that you’re looking from the outside looking in and hearing what their goals might be and seeing and giving them opinion. Can you really get there or not?
And if not, you’ll tell them this isn’t going to work.
Henry (52:57 – 53:11)
Yes. Yeah. And the beautiful thing about my business is that the numbers tell the story.
Like I said, I run a few scenarios and I don’t need to explain it to you. You can usually see it when I lay it out for you. Hey, this works or this doesn’t work.
Armando (53:11 – 53:28)
Yeah. And then we’ll take those numbers and we’ll project them forward five and 10 years for contributions and then out to age 100 so they can see what does that impact really have on them and their family from an overall financial perspective?
Henry (53:29 – 53:29)
Definitely.
Armando (53:30 – 53:33)
Good. All right, Henry, thank you so much. We appreciate the conversation.
[Speaker 3] (53:34 – 53:35)
Thank you.
Armando (53:36 – 54:11)
Again, they can reach out to you at 602-944-1515. Thinking of exiting your business? You may have only one chance to get this sale right.
Your family depends on it. Come hear experts who plan and negotiate successful business exits for a living. Bring your questions, live panel discussion, followed by Q&A.
Join us Thursday, April 27th, 2023 at the next Scottsdale Founders Forum, a biannual live event for the founder considering exiting in the next five years. More information available at ScottsdaleFoundersForum.com.
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