Retirement Planning for the Small Business Owner
Despite their relative complexity, retirement plans are one of the best tax breaks available. By contributing to a plan, an individual can both cut taxes and save for retirement. Businesses that offer retirement plans to their employees can not only cut their taxes, but also they may be better able to attract and retain talented employees.
Retirement plans come with a confusing variety of names, options and requirements. Finding the plan thatâ??s best for you can be challenging. Itâ??s important, too, to review plan options periodically as the tax rules and your circumstances change. The following is a brief introduction to the plans that are available for the small business owner.
SIMPLE-IRA (Savings Incentive Match Plans for Employees) are available to self-employed individuals and to businesses that have no other plan and 100 or fewer employees. SIMPLEâ??s permit employees to make pre-tax contributions to a SIMPLE-IRA or a SIMPLE 401(k). Employers are required to make up to a 3% contribution for each eligible employee.
The main attraction to SIMPLEâ??s is that they are easier and less expensive to administer than traditional company retirement plans.
A SEP (Simplified Employee Pension) is also known as a SEP-IRA. This retirement plan lets you establish individual retirement accounts for yourself and your eligible employees. A SEP is most beneficial if you are self-employed with no other employees. Setting up a SEP can be as simple as completing a short, written agreement. If you have employees an annual disclosure statement is the only filing requirement.
A SEP must be funded by company contributions and contributions to employee accounts must be at the same percentage as those for the owner. But an employer can decide each year how much to contribute (similar to a profit-sharing plan). Unlike other plans, SEPâ??s can be established up until the extended due date of your companyâ??s tax return.
Keogh Plan - Only sole proprietorships and partnerships can set up a Keogh plan. Contributions provide tax deductions for the business and tax-deferred earning for the employees. There are different types of Keoghs, some requiring annual contributions and some allowing contribution flexibility based on a companyâ??s profitability.
401(k) Plan â?? Under a 401(k) plan, workers can elect to have their employer contribute part of their salary to the plan. Though these plan contributions are subject to social security tax, they are not subject to income tax until money is withdrawn from the account. A 401(k) can permit employer contributions, such as matching or profit-sharing contributions. Because 401(k) plans can be costly to administer, and they are subject to complex tax and reporting requirements they are not generally recommended for small business.
Solo 401(k) Plan - The solo 401(k) plan is designed for businesses where the owner is the only employee. Solo 401(k)s are less complex, less burdensome, and less costly to manage than traditional 401(k) plans.
Both incorporated and unincorporated businesses can set up a solo 401(k) plan. For the purposes of a Solo 401(k), even if youâ??re self-employed, youâ??re considered an employee of the business. Under an individual 401(k) plan, you can elect to contribute part of your earnings to the plan, and your business can also make tax-deductible contributions to your account.
Roth 401(k) Plan â?? Created as part of the Tax Act of 2001, Roth 401(k)s became available as of January 1, 2006. However, not all employers offer these accounts, since amending an existing 401(k) plan to include Rothâ??s is optional.
With a regular 401(k), your elective salary deferrals reduce your taxable income and grow tax-deferred â?? meaning youâ??ll owe income taxes on distributions taken from these accounts down the road. Contribute to a Roth 401(k) instead, and you lose out on the current deduction for your salary deferrals, but your contributions grow tax-free and can be withdrawn tax-free, provided certain conditions are met.
Making a Decision â?? This brief overview by no means includes all the details you need in order to make informed decisions about retirement plans. Not every plan is available to everyone. Contributions limits vary, depending on the plan, your income and your age. Withdrawals may be required at a certain age for some plans, and they may be taxed or tax-free depending on the rules governing the particular plan. A tax credit may be available to some business for setting up a plan and to some individuals for contributing to a plan.
The rules for retirement plans are among the most complex in the tax law. BEFORE you make decisions in this area, call us. We are here to help.
By Judee Slack, EA, CFP, CSA
