The retirement plans our parents used are a thing of the past:’ says Rick Laspaluto, a registered representative with Tri-Star Management, Inc., in Las Vegas.
“One third of your retirement needs will come from Social Security,” adds Phillip Leathers, an investment representative for Edward Jones Investments. “One third from Social Security. Do you figure it will still be there? Good question. And where do you get the other two-thirds? From quality retirement planning hard at work.”
But in today’s working world, employers are hesitant about starting retirement plans. The cost of managing many of the plans is prohibitive. But without a quality plan, keeping good employees — or getting them in the first place — is difficult. With such a tight labor market, employees have the option and opportunity to seek employment with the employer who offers the best benefits package.
A lot of small businesses, companies with 10 or 20 employees, don’t have retirement plans, says Laspaluto. In this instance, there are two variations to consider when choosing the plan’s framework — a corporate plan or an individual plan.
“One neat benefit to being a small business owner is individuality,” says Leathers,”which can also be the downfall.” Very often for the self-employed or small business owner, the idea of talking to the competition, of approaching the competition for any reason, is threatening. But he recommends it. “You don’t have to join forces, you don’t have to ask them questions about how they run their business. Ask them about taxes, what they’re doing about their retirement planning, their tax planning, their legal planning. Find someone whose business style you can emulate. It doesn’t mean you’re weak in competition; you’re strong in planning.”
At Edward Jones, a checklist helps individuals choose a retirement plan that will work for them. The checklist assists by determining variables such as planned annual contributions, present age, planned age of retirement, current retirement savings and other factors.
The type of plan a small business owner or self-employed individual is going to choose is dependent upon several objectives, Brooke Del Mastro with Northwestern Mutual/Baird points out. Not only is the retirement age savings goal an important criterion, but the individual may also want to save money on taxes, retire early at age 50, or save money to buy a building. “So when small business owners are sitting down to look at a retirement plan, I think it’s very important for them to be sitting down with someone who can advise them while keeping in mind their other goals and objectives,” she says.
A variety of options are available. Some plans for individuals include traditional vehicles such as the IRA, but a traditional plan mayor may not be tax deductible, says Laspaluto. It depends on the individual’s annual income and whether he or she is covered by a company-sponsored plan. With the Roth IRA, the individual can contribute $2,000 per year but these contributions are not tax deductible. Thus, the money that goes in is already taxed and any earnings in the account can be withdrawn, tax free, after age 59- or in the event of a first-time home purchase, disability or death.
What’s Available
Until recently, the problem for small business owners and the self-employed who sought to provide a retirement plan was cost. Then in 1998, new tax rules changed things by introducing the SIMPLE 401(k) and the SIMPLE IRA. Employees can now take more control of their savings, and direct pre-tax income into their own tax-deferred qualified retirement plan.
“If you to contribute as an employer, making contributions on [employees’] behalf annually, you can set up a vesting schedule to encourage people to stay a little longer, to attract and encourage good quality folks,” says Leathers. ‘Perception paints retirement plans as very costly and quite time consuming. To the contrary, they can be very low cost and not at all time consuming for businesses?’ At least for a SIMPLE or SIMPLE 401(k), depending on the number of employees. The smaller the company, the fewer the requirements for record keeping and filing returns. The government really wanted to give employers an incentive to take care of their own retirement by creating the two new plans.
The SIMPLE plan (Savings Incentive Match Plan for Employees) i5 a form of IRA account most small businesses are eligible for. There’s a maximum cap of 100 employees under the plan, and the requirement that employees earn at least $5,000 in any two prior years and expect to earn a minimum $5,000 in the current year. The maximum annual employee contribution to the account is $6,000, while the minimum employer contribution is a 3 percent match.
A few advantages are offered by the SIMPLE plan: for employers, contributions are tax deductible; for employees, pre-tax contributions reduce their taxes; each employee, including the owner, can defer up to $6,000 annually. Employees earning less than $5,000 can be excluded from the plan. Once a business chooses a SIMPLE plan, no other qualified plan is permitted. But benefits outweigh potential negatives.
“We do a lot of SIMPLE IRA plans:” says Pat Corcoran, vice president, American Investment Services. “With most IRAs you’re only allowed to put $2,000 into the fund. This one allows you to put in $6,000 a year, no matter what, as long as you earn the $6,000. It then allows another 3 percent of gross income, so if a person is making $100,000 a year, he or she can put away $6,000 plus another $3,000, or $9,000. And the employer must put 3 percent away for each employee. That doesn’t sound like very much, and it really isn’t from the employer’s standpoint, but it gives the employee a chance to put away money for retirement. It’s an ideal plan for a small business:,”says Corcoran. “The administrative cost is only $10 a year per employee.”
Passed by Congress in January 1997, the SIMPLE plan is relatively new and true to its acronym. “Most people don’t have any idea about it’ says Corcoran. “And [with the plan] when you do a mutual fund, plan administrators do all the reporting, they fill out all the tax forms, and give you all the forms each year, and it still only costs $10 a year for each employee.”
Traditional plans do things differently. A 401(k) plan can cost upwards of $6,000 a year administratively. With a Keogh plan, a profit-sharing defined plan, once you get into one of those, you must make a contribution each year, even if you don’t make money, says Corcoran. Their administrative costs run around $1,200 a year for a small business, and you must make a contribution, whereas with the SIMPLE plan you don’t have to. “I’ve been a broker for 20 years and it’s the most flexible plan I’ve ever seen.”
Another benefit to the plan is that just like with a 401(k) plan, individuals can get money distributed on death, disability and a divorce decree, with the divorce making the funds community property and splitting them in half. And money can be withdrawn for qualified medical expenses, health insurance payments, higher education expenses and first-time home purchases.
The SEP IRA, Simplified Employee Pension plan, is good for almost any business and requires employees to have worked for the company for three to five years, which goes some distance toward attaining and retaining qualified workers in a small business. Contributions are limited to the lesser of either 15 percent of annual compensations or $30,000, and contributions are flexible.
Some advantages of a SEP are contributions are tax deductible, contribution amounts can vary from year to year, and the employer shoulders no responsibility for employees’ investment decisions.
The SEP is the simplest form of employer-sponsored retirement plan, says Laspaluto. Contributions may not exceed 15 percent of compensations it’s a tax deductible investment, and the money is tied up until age 59 ½. Only the employer can make contributions to a SEP, and the plan is also fairly inexpensive to manage, generally carrying a $10 or $15 annual fee.
A profit-sharing plan requires employees to have worked for the company for two years, as does a money purchase pension plan. Contribution limits for a profit sharing plan are the same as for a SEP. For the money purchase plan, contributions are limited to the lesser of 25 percent of annual compensation-or $30,000. Contributions are also tax deductible and amounts can vary from year to year. The employer can exclude part-time employees working less than 1,000 hours in year, and vesting schedules can be used to reduce the cost to the employer, or for the non-employer.
“If you don’t have employees what plan is best for the small business owner?” asks Leathers. “Well, for example, I use a plan right now where you can defer up to 25 percent of your gross not to exceed $30,000. It’s called a Paired Plan, a SEP paired up with a money purchase plan.”
Other Options
There are basically only three alternatives for small business owners for funds they can tap into without penalty from the IRS before age 59½, explains Del Mastro. There can be real estate sales, or rental property that’s paid off that the individual can thaw income from, but a lot of small business owners pour everything they’ve got into a small business, and they don’t have real estate. Another alternative would be a taxable portfolio, assets in mutual funds, stocks, CDs, money market accounts that are not inside a tax-qualified plan. But as those assets get bigger, there’s a tax due at the end of every year. There are tax ramifications with respect to real estate income and taxable portfolio income.
“One final way,” says Del Mastro, “and not too many people are aware of it or believe in it, is using cash values of life insurance because life insurance grows tax deferred.” There’s not a tax impact like there is with a taxable portfolio, and because of the IRS definition of life insurance, the way to pull money out is via a policy loan which is not considered a taxable distribution. “So life insurance protects either your family or business, whatever you’re trying to protect with the life insurance death benefit, and cash value growth inside the policy actually provides a means to have a tax free stream of income in the form of policy loans from the cash value:’ Del Mastro noted.
In Del Mastro’s experience, many small business owners and independents, such as CPAs and commercial real estate agents, are able to defer income into SEPs for the tax break, but are unable to save enough to maintain their lifestyle after retirement. “So what they’re doing,” Del Maestro says, “is putting money into cash value life insurance, because in certain foams of life insurance, it will outperform a taxable portfolio because it is tax deferred.”
“If owned properly, an insurance policy can offer tremendous value to what you’re trying to accomplish:’ says Leathers. “Are you buying it as a retirement plan so it can be tax deferred or as a death benefit? Could be one of each or both. It’s an expensive way to plan for retirement, but it offers tax-deferred growth, and as long as the policy remains in force, with premiums paid and not allowed to lapse, you can start to withdraw an income stream from the cash value in that policy. And when you withdraw money as a policy loan, it comes out tax free.”
