Business & Finance
RETIREMENT PLANNING FOR SMALL BUSINESSES AND INDIVIDUALS – It’s Not Too Late
No matter what age you are, retirement planning is smart and forward thinking. Those that do will have and those that don’t won’t. Starting a plan today no matter how small will make your life in the future more comfortable.
There are three types of retirement plans that are available to you - Individual Retirement Accounts (IRA’s), Corporate Plans and Self-employed Retirement Plans. Each has its own advantages and disadvantages. I will explain the differences in this article.
INDIVIDUAL RETIREMENT ACCOUNTS (IRA’s)
There are two types of IRA’s - the Roth IRA and the traditional IRA. The Roth IRA is not tax deductible and the income is not taxable when it is withdrawn at retirement age. The traditional IRA is tax deductible and is also taxable when it is withdrawn at retirement age. In general the Roth IRA is a better option when you are young or when you will be in a higher tax bracket upon retirement. The traditional IRA is a better option if you will be in a higher tax bracket in the year of contribution.
IRA’s are available to small business owners as well as individuals. There are limitations on allowed deductible contributions based on your adjusted gross income (AGI) for employees and their spouses who are active participants in a retirement plan maintained by the employer.
The maximum contribution for an IRA in 2004 is $3,000. An individual who will be at least 50 years by the end of the tax year is allowed to make a “catch up” contribution of $500 for a total of $3,500. These amounts are projected to increase for the years 2005 through 2007 to $4,000 for those under 50. For those over 50 they can make an additional “catch up” contribution of $500 in 2004 for a total of $4,500. The catch up contribution increases to $1,000 in 2006. You must have compensation at least as much as your IRA contribution in order for it to be deductible.
CORPORATE RETIREMENT PLANS
There are three types of retirement plans available - SEP (simplified employee pension), SIMPLE Plans including Simple IRA and Simple 401k (savings incentive match plans for employees), and Qualified Plans including Profit Sharing Plans, Money Purchase Plans and Defined Benefit Plans.
The maximum contribution for SEP plans is the smaller of $41,000 for 2004 or 25% of the participant’s compensation. The maximum deduction is 25% of all participants’ compensation. The last date for contributing to the plan is the due date of the employer’s return including extensions and the plan can be set up any time up to the due date of the tax return.
SIMPLE IRA and SIMPLE 401(k) PLANS
The maximum salary reduction contribution for the employee is $9,000 for 2004. Employees over 50 can make an additional catch up contribution of $1,500 for 2004. The employer contribution and deduction is either dollar-for-dollar matching contributions, up to 3% of the employee’s compensation or fixed non-elective contributions of 2% of compensation. The last date for contribution to the plan for the employee’s portion is 30 days after the end of the month for which the contributions were made. The employer matching contribution is due no later than the due date of the employer’s return. The plan may be setup prior to October 1st of the calendar year except for new corporations which have an extended deadline.
There are Defined Contribution Plans – Money Purchase and Profit-Sharing Plans. There are also Defined Benefit Plans. The key to understanding the difference between these plans is “contribution” and “benefit.” Defined Contribution Plans are based on current compensation. Defined Benefit Plans are based on the amount needed to provide an annual benefit upon retirement. Defined benefit plans work best for someone who has the cash and wants to make large contributions to their retirement. This may also be beneficial to employees nearing retirement that need to catch up on their retirement contributions.
The maximum contribution to Money Purchase and Profit-Sharing Plans is the smaller of $41,000 for 2004 or 100% of participant’s compensation. The maximum deduction is 25% of all participants’ compensation. For Profit Sharing Plans, each year you can choose to contribute anywhere between 0% and 25% whereas Money Purchase Plans require a fixed amount for all of the years so Profit Sharing Plans have a real advantage here. The last date for contribution is the due date of the employer’s return and the plan needs to be set up by the end of the tax year.
For Defined Benefit Plans the maximum contribution is the amount needed to provide an annual benefit no larger than the smaller of $160,000 or 100% of the participant’s average compensation for his or her highest 3 consecutive calendar years. The maximum deduction is based on actuarial assumptions and computations. The last date to contribute is the due date of the employer’s return except for a plan which is subject to minimum funding requirements. In this case the payments are due quarterly. The plan needs to be set up by the end of the tax year.
The expense deduction for all of these plans is deducted directly from income. This is a real advantage for tax purposes vs. a self-employed individual. All employees must be treated equally and get the same benefit as the owners. There can be no preferential treatment to a select few. Therefore, it is important to understand what specific plan works best under your circumstances taking into consideration employees, profit and cash available along with your personal goals. S Corporations shareholders can not take deductions based on their pro rata share of pass-through income from the S Corporation. This can be a real disadvantage for the S Corporation small business.
All of these plans can be relatively easy to set up and some are not very difficult or costly to administrate. Many of them can be accomplished in house and won’t require hiring a pension plan company to create and administer the plan which can become too costly for a small business. T. Rowe Price Associates is one company of many that can provide the retirement plan which will be compliant with IRS Regulations, free of charge. All of their mutual funds are no load (which means you do not pay anything when you buy or sell it) and their funds have a good performance record. You can view their web site at www.troweprice.com/smallbusiness. It has information on individual retirement and workplace retirement plans along with historical performance on all of their funds.
SELF-EMPLOYED RETIREMENT PLANS
The rules are the same as CORPORATE RETIREMENT PLANS except for one important difference. For self employed and partnership entities who have a SEP or Qualified Plan, the deductible contribution for the owner only (not common law employees) is on line 30 of your 1040, not on your Schedule C or Partnership Tax Return. This can be a real disadvantage since it is after your deduction for Social Security and Medicare and your deduction to the plan.
This article was intended to provide general information about retirement plans. It does not contain all the rules and exceptions that may apply to your situation. If you have further questions regarding retirement options, I can be reached at firstname.lastname@example.org or the website and number below.
Coming Soon - What New (and existing) Business Owners Need to Know - Part 1
Dianne Goodman, CPA
Comprehensive Small Business Solutions, PC
1 866-531-3035 toll free
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About the Author
Dianne Goodman, CPA –Specializes in servicing Small Businesses and Individuals. Visit www.dgoodmancpa.comfor relevant and current information on a variety of financial and tax issues focusing on small businesses and individuals or call at 1-866-531-3035.
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