FINANCE: Business Owners can Have Flexible Retirement Plans
Column by Patricia Kummer, CFP
Many business owners are not aware of the many types and benefits of qualified plans. Often we tend to think that 401(k) plans and saving for retirement is something big corporations or high profit companies can do. The fact is small businesses often have more flexibility than their larger counterparts due to fewer employees and more financial control.
First identify what is your goal for retirement savings. Once you determine this, then finding the right plan is easy. Keep in mind that your contribution into a qualified retirement plan can be a tax savings both to you and the business as well. Therefore don't assume that if you don't have profits you are not eligible for contributions.
A typical Defined Contribution plan allows you to fund a certain amount each year. This is most common in the form of a 401(k) plan that usually allows a participant to contribute up to $16,500 ($17,000 for 2012) with a $5,500 catch up for anyone over the age of 50. This plan also allows the employer to match up to a certain amount or add pre-tax profit sharing. This can turn out to be a tremendous tax savings to the participant and the company. You may also choose the post-tax Roth election for future tax-free growth.
Let's say you will turn 50 before year-end and will take a salary of $100,000. You would be able to defer $22,000 in the employee contribution. Now as an employer you can match dollar for dollar, up to an amount you are comfortable with. If you only have a few employees, and you are the only one maximizing your contribution, matching 100% up to 4% of income may be very beneficial.
In this case you would be matching yourself another $4,000. You may also want to include profit sharing up to a certain point as well. Let's say your goal is to fund $30,000 each year. If you already have $26,000 accounted for, take the remaining $4,000 and divide into your salary which equals another 4%. Now you must offer the same percentage to any eligible, full time employees. If you only have one or two other employees, earning $35,000, then you have to fund $1,400 for them. This is a low price to pay to allow the maximum savings to yourself.
This type of plan benefits the owner the most if there is a significant difference in wages between the business owner and other employees, or if the employees are not funding their plan or have not worked there long enough to be eligible. You do have to have this type of plan tested each year to make certain you are not out of compliance. If so, there will be certain amounts that may need to be funded, usually three percent to pass the discrimination test.
Many small businesses only have family as employees. In this case, the Single 401(k) plan works well as you are only funding for your family and there is no compliance testing.
Other plans which may be a good fit include the SIMPLE which allows employees to defer and requires a much smaller employer contribution. However this does not allow the owner to put as much away.
For businesses where there is a large age difference, you may want to consider a Defined Benefit plan. This type of plan favors older employees by funding an amount needed in retirement. The closer you are to retirement age, the more you are allowed to fund.
The SEP or Simplified Employee Pension plans still work well for the sole proprietor, however if you are trying to fund the maximum, you may want to look into a 401(k) plan or if your employees also want to defer some of their income. These contributions are based on a percentage of total net revenue from the business or commonly called ‘bottom line Schedule C'. These are employer-paid plans and work best if you do not have any eligible employees.
The first step in evaluating which plan is best for you is to gather the census information for your employees and identify if the group wants to defer some of their income or if you as the employer will be making all of the contributions. Then meet with a qualified advisor to compare plans and choose the best option for your situation. You can offer a great benefit to your employees and accumulate a substantial amount towards retirement. You and the business can also take advantage of significant tax-savings by putting a good qualified plan in place.