Retirement Plans, Part 1
By Carl Sanger
Locked out of a retirement savings plan because you own or work for a small business? Now, you can have all the retirement savings advantages the big companies do!
There was a time when only the very large firms could offer a formal retirement plan for their owners, officers and employees. In fact, giving up the opportunity to partake in a retirement plan was one of the big sacrifices you made if you wanted to work for yourself or own a small business. Well, thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001, and more tax legislation passed in 2002, this situation has completely reversed itself. The fact is that, even in these turbulent times, there are things you can do, regardless of the size of your business or workplace, that can ensure you have a prosperous retirement.
What has changed?
Where you once had to rely on making paltry contributions to your IRA as your only tax-advantaged vehicle to save for retirement, you now have a number of bona-fide investment plan choices that will let you retire in style. Under the new rules, you can:
- create your own tax-advantaged retirement fund and contribute generously;
- offer a comprehensive retirement plan when recruiting new employees;
- retain your better employees ? they'll no longer have reason to leave your company for another company just for the sake of getting a retirement plan; and
- reap the same tax advantages as the larger firms get when making retirement plan contributions.
What Retirement Plan Choices do I have?
In this first of two articles, let's take a look at some of the pros and cons of three of the more popular types of plans. If you would like additional information about how to set up, maintain and manage one of these plans or any of the other plans available, I recommend that you seek an investment advisor skilled in this specialized financial field. He or she will be able to work with you on setting up a plan for you and/or your employees that will not only meet your retirement goals, but maximize your tax benefits as well.
The Solo 401(k) Plan: This is, by far, the hottest new retirement strategy being used by businesses where the owner or owners are the only employees. The Solo 401(k) Plan is ideal for sole-practitioner professionals, small retail business owners, freelance writers and consultants, among others. This plan can even be contributed to solely from part-time income. (Of course, if you work for another company full-time and contribute to their 401(k) plan, you cannot exceed the maximum allowable annual contribution between the two plans.)
Boasting one of the more generous contribution limits, this plan allows you to contribute on your own plus have your own company match a percentage of your personal contribution up to an annual total of $40,000 or 100 percent of your income, whichever is less. So, if you earn $160,000, for example, you could contribute the legal limit of $11,000 personally and your company can contribute the difference up to 25 percent of your earnings, making a total annual contribution of up to $40,000. And, just as with all 401(k) plans, the contribution you make is deducted from your gross income, lowering your tax burden. If you are age 50 or older, you also are even allowed to contribute an extra $2,000 above the annual limit as a "catch-up" provision.
The major drawback to the Solo 401(k) Plan comes into play if you decide to hire an employee who is not an owner of your company. In other words, if you have a small business and you one day plan to expand and hire more employees, you could open a can of worms. If you have a 401(k) plan already in place, and you decide to hire a non-owner employee, you now have new administrative, fiduciary and financial responsibilities that extend to your employee. In most cases, you would have to start making contributions to your employees' 401(k) accounts, not just your own. If you fail to contribute to your employees' 401(k) accounts, yet continue to contribute to your own, you would most likely not pass the "non-discrimination test." This test exists to ensure all employees are treated evenly and fairly. With a 401(k) plan, if you contribute for one, you must contribute for all.
Simplified Employee Pensions (SEPs): This second, very popular plan lets you set up a generous IRA for you and your employees. With this scenario, however, employees do not make any contributions on their own behalf. The plan is funded entirely by employer contributions. You, as the employer, however, have wide flexibility in deciding how much to contribute and when to contribute. In fact, you can vary what you decide to contribute from year to year and do not even have to make contributions at all in any given year. This eases your responsibilities if your business is cyclical or experiences some hard times. Maximum contribution limits are, like the Solo 401(k), the lesser amount of 25 percent of earned income or $40,000 annually. (This limit is linked to the rate of inflation and will increase over the coming years.) A big advantage to SEPs is that administrative requirements are minimal when setting up and maintaining this type of plan.
SIMPLE IRA Plan: Unlike the SEP plan, the SIMPLE IRA allows employees to contribute a percentage of their income each paycheck and requires you, as the employer, to contribute a percentage, as well. Employees can decide how much they want to contribute up to a maximum of $8,000 per year (going up each year by $1,000 until the limit becomes $10,000 in 2005). As with the other plans, there is a catch-up provision for those over age 50; an additional $1,000 can be contributed over and above the annual limit in 2003. Employee contributions are made by payroll deductions. You, as their employer, have to match employee contributions dollar for dollar up to three percent of the employee's compensation. Or, instead, you can opt to make a fixed contribution of two percent of compensation for all eligible employees.
Please keep in mind that space limitations do not allow me to describe all the advantages and disadvantages of each type of plan mentioned, nor does it allow me to cover the whole spectrum of plan choices that now exist for you. In next month's article, however, I will delve into the other types of plans that are available for you, such as Profit-Sharing Plans, Defined Benefit Plans, Defined Contribution Plans, Money Purchase Plans and more. Certainly, in the meantime, you can feel free to contact me with any questions.
These investment plans may seem, on the surface, like a long overdue way for small business owners to save for retirement. Perhaps, though, government is also hinting that we should take the notion of preparing for our own retirements seriously. Considering the rumored uncertainty of our Social Security system, we should heed this message being sent.
Perhaps, more than a half-century after Franklin D. Roosevelt's days, our elected officials are still recognizing his wisdom. Roosevelt once said, "True individual freedom cannot exist without economic security and independence." A modern interpretation of this might be, "Plan for your financial security now. Don't limit your personal freedoms in your golden years to whatever financial help government programs or your loved ones can afford to supply."
About the Author
Carl Sanger is the owner of Serenity Wealth Management, LLC in New York. Sanger is a Registered Investment Advisor and has been managing investment-capital for 10 years.