Tax-Advantaged Retirement Plans
Small-business owners can choose from a variety of tax-advantaged retirement plans. The easiest to administer tend to have lower limits on how much the owner can contribute and usually require that other employees be included, which can increase costs.
Some business owners look for plans that specifically allow them to contribute heavily to their own retirement while excluding other employees. Carefully designed defined-contribution and defined-benefit plans may allow them to do so, especially if the owner is significantly older than the employees, said Raymond W. Liden, principal of Westlake Village pension administration firm Liden, Morton, Nestle & Soled. These plans are often expensive to administer because of strict rules that, if not followed carefully, could result in the Internal Revenue Service disqualifying the plan.
The type of plan chosen also depends on the small-business owner’s attitude about whether he or she has a duty to provide retirement accounts for employees. Some employers feel retirement benefits should accrue only to them, because they have taken the risk of starting and running the company, while others want a retirement plan as a recruitment and retention tool for employees or because they feel a moral obligation to help provide for employees’ retirement, said Greggory J Hutchins, a certified public accountant and tax partner tax and accounting firm Holthouse Carlin & Van Trigt in Westlake Village.
The most common types of retirement plans for small-business owners include:
* IRA and Roth IRA: Individual retirement accounts and Roth IRAs can be set up by anyone with earned income, even if the individual has a retirement plan at work. The employer has no obligation to fund an employee’s IRA or Roth IRA.
* SEP-IRA: A simplified employee pension is a kind of “super IRA” that allows business owners to set aside up to 13% of net income, up to $24,000. Employees older than 21 who earn more than $400 must be included in the plan.
* Keogh: There are two types of Keogh plans for the self-employed. Money-purchase plans require a fixed contribution of up to 20% for the business owner and 25% for employees, up to $30,000; these plans are best for well-established businesses with predictable cash flow. Profit-sharing plans allow business owners to make a discretionary contribution each year of up to 13% for the business owner and 15% for employees, also up to $30,000. This type is better for newer businesses with uncertain cash flow.
* SIMPLE: The savings incentive match plan for employees is another kind of beefed-up IRA that allows contributions of 100% of earned income, up to $6,000. The business must contribute 2% of each employee’s earnings, whether or not an employee participates, or match participating employees’ earnings by up to 3% of their salaries. This match can be reduced to 1% for two out of every five years. Employees earning at least $5,000 must be included in the plan.
* Defined contribution: These plans, which include 401(k)s, are more expensive to set up and administer than any of the preceding plans but can allow contributions of 20% of income. They can generally be limited to full-time employees; other restrictions may be possible, as well.
* Defined benefit: These traditional pension plans pay a set amount in retirement, typically based on salary and years of service. The pension can provide a retirement income of up to 100% of pay, to a maximum $120,000. Contributions to the plan are based on actuarial assumptions about how much needs to be set aside to provide the pension amount, which means an older owner can set aside minimal amounts for younger workers and substantial amounts for himself or herself. Like defined-contribution plans, defined-benefit plans are expensive to set up and administer.
