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Tuesday
Mar192013

Small Business Retirement Plan Options Every Attorney Should Know

I hear it so often, “My small business client wants to have a retirement plan. What’s the best option?” As with almost any question in law the answer depends on the client’s objectives.

Saving for retirement can be especially hard for small business owners. Making bills and the daily pressures of running a business can make saving a low priority. Even if a business is very profitable, traditional retirement plan options do not always allow the business owner to save in a way that might actually allow for a good amount of income replacement when they reach retirement age.

The most common retirement savings is done through traditional and Roth Individual Retirement Accounts or IRAs. The problem with IRAs is they offer extremely low contribution limits ($5,500 yearly limit, $6,500 if over age 50). These limits are far too low for a small business owner to save enough to have sufficient income replacement as they head into retirement. However, small business owners can offer and take advantage of retirement plans with significantly higher contribution limits and tax benefits.

This article is meant to be a brief synopsis of five specific types of retirement plans that provide greater opportunity for tax deferred savings to small business owners that hopefully will give them a leg up in their overall financial plan.

SEP IRA

A Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) allows a business owner to contribute a portion of the company profits pretax to each employee and to themselves. These contributions are based on a percentage of each employee’s earned income. The maximum contribution for 2013 is the lesser of $51,000 or 25% of an employee’s compensation or for a business owner 20% of their net earnings from self-employment. All contributions grow tax-deferred until they are withdrawn at retirement age. All plan contributions can be taken as a tax deduction to the business, thereby lowering taxable income. The SEP IRA does not allow for employee deferrals of any type and additionally you cannot borrow from a SEP.

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA gives each employee the option to make pre-tax deferral contributions from their salary into a retirement savings account. The limit for 2013 is $12,000. Participants over the age of 50 can contribute an additional $2,500 per year pre-tax. The employer is required to make a matching contribution of up to 3 percent of the employee’s compensation. As with an SEP IRA, the employer contribution is tax-deductible. While the contribution limits are not as high as the SEP, the SIMPLE IRA is a good solution for companies with employees that want to save a portion of their own income for retirement.

Individual or Solo 401(k)

The Individual 401(k) is designed to help sole proprietors (and their spouses) save more for retirement. Contributions are based on a percentage of income and in 2013, each participant can save up to $51,000 in the plan (those over the age of 50 can contribute an additional $5,500 in 2013). These contributions will not be taxed until they are distributed at retirement, and employer contributions subject to certain limitations can be used as a tax deduction for the business to offset taxes. The Individual 401(k) is appropriate for a sole proprietor with no plans to add additional employees. The biggest advantage of the Individual 401(k) over the SEP is that it allows the business owner to reach the maximum contribution level ($51,000) at a lower level of income.

Traditional 401(k)

The traditional 401(k) is designed to help employees save more for retirement. As of 2013 each participant can save up to $51,000 in the plan. The elective deferral limit for employees is $17,500 and those over the age of 50 can contribute an additional $5,500 in 2013. These contributions will not be taxed until they are distributed at retirement age, and employer matching and profit sharing contributions, subject to certain limitations, can be used as a tax deduction for the business to offset taxes. The 401(k) is appropriate for almost any business. The biggest advantage of the Individual 401(k) is that it allows employees to save for themselves and matching contributions can be optional.

Defined Benefit Plan

Defined Benefit (DB) plans offer business owners the opportunity to save many times what they would with other defined contribution options like 401(k)s SEPs and SIMPLEs. With a DB plan, the contributions are based on a projected retirement “benefit.” In other words, a business owner decides how much income they want at retirement (up to the 2013 benefit maximum of $205,000) and an actuary determines how much is needed to contribute to the plan each year. The DB plan is a great savings tool for a family business or a business with only a small number of “rank and file” employees. DB plans can be much more costly to implement and administer than other types of retirement plans and the plan sponsor needs to engage an actuarial firm to create the plan document and calculate the contribution amounts. It is also worth contacting an investment advisor to assist with the management of the portfolio.

Finding the right type of retirement plan to fit a client’s need is a critical piece of counseling small business owners. Company-sponsored retirement plans offer the benefits of tax-deferred growth, tax-deductible contributions and higher contribution limits than Individual Retirement Accounts. The decision about which plan to choose should be made within the context of a client’s overall goals and the size and profitability of a business.  Finally, do not be afraid to seek assistance if you feel you are out of your element in counseling an employer about retirement plan options!

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