Owners of small businesses are a special type of person – ambitious, goal-oriented, enthusiastic, and likable. They also are experts at stretching a buck – except, perhaps, when it comes to saving for retirement. The pressure of running a successful business often means that retirement planning is neglected. But then, where are they when they want to retire? Will they have enough in savings or from selling their business to retire comfortably?
The benefits of establishing a tax-qualified retirement plan are well known: tax-deductible contributions, tax-deferred growth, and protection of plan assets from creditors. A good retirement plan can also help a business retain and recruit key employees.
Yet, despite all of their benefits, business owners frequently shy away from retirement plans. Why? Perhaps it’s because they don’t know enough about them, or they don’t know which plan would be best for them (and their employees). They may also think that retirement plans are too expensive and complex to administer. So, they default to a SIMPLE IRA or SEP IRA, which are easy to administer, have lower contribution limits, and generally are not able to provide business owners with the retirement income that they need.
Let’s see if we can address some of these concerns.
First, what kinds of retirement plans are there?
There are two basic types of qualified retirement plans:
Small business owners have a lot to consider when choosing a retirement plan. And the myriad of plan design options can be overwhelming. That’s where a financial advisor who is experienced and knowledgeable about retirement plans can be invaluable. So, let’s look a little deeper at some of these plans.
A profit-sharing plan is a qualified retirement plan that gives the small business owner flexibility in designing the plan’s key features, as well as allowing discretionary contributions. The employer can decide each year how much to contribute to the plan. The employer can also elect to make no contributions in years in which earnings are low.
A business owner also has the flexibility to choose how they want contributions allocated among employees:
A 401(k) plan is a good option where the employer wants to rely on employee contributions. Employees, including owner-employees, defer a percentage of their salary on a tax-deductible. A 401(k) plan also allows the employer to make matching contributions.
There’s a limit, however, to the amount of matching contributions a self-employed individual can make which involves using a special formula to calculate contributions based on net earnings minus one-half self-employment tax and employer contributions (more on this in Part II of this discussion).
A popular design feature is to pair a profit-sharing plan with a 401(k) plan, thus taking advantage of the tax savings and maximum contribution limits of each type of plan.
Unlike a defined contribution plan, where the benefit depends upon the investment earnings of contributions, a defined benefit plan provides a guaranteed monthly annuity for life at retirement. There are a number of different defined benefit plans.
Small business owners often find themselves needing to play catch-up for retirement because they’ve spent a lot of time and money growing their business instead of saving for retirement. As a result, they look for a retirement program that will let them save a lot in a short period of time.
This means a well-designed retirement plan is a must. 401(k) plans by themselves cannot provide sufficient savings. But pairing a cash balance plan with a 401(k) plan gives the business owners additional options to take advantage of the tax savings and maximum contribution limits of each plans.
Which retirement program a business owner selects is very personal, taking into consideration the cost versus the ultimate benefit for the owner and the employees.
Retirement planning options can overwhelm the small business owner. So, it’s important for them to enlist the assistance of a good financial advisor – you – and explore the details of what they want for themselves and their employees before making a final decision.
Some advisors prefer to work with large companies and large plans, but the small business market can prove very rewarding.
We, in the Pension Division of RMC Group, specialize in working with advisors who serve the small plan market. We can help you market, set up, and administer your clients’ profit-sharing or other qualified plans.
Click here for an easy to read chart that explains each retirement plan’s key attributes and their benefits.
Call 239-298-8210 or visit our website at rmcgp.com to discover how we can partner with you to help small businesses successfully set up and administer a profit-sharing plan.