Retirement Planning for the Business Owner

When you started up your business, most likely you envisioned a time when you could walk away with enough money to live comfortably. That's a do-able goal, but you have to plan for it now. Whether you want to stop working at age 50 or to work as long as possible and pass your money on to your children, you can set up a retirement plan to help you achieve your goals.

This article is designed to start you thinking about establishing a retirement plan for your business. The law gives you plenty of options, and your lawyer can help you determine which is best for you. In future articles, we will look at some specific options, such as SIMPLE (Savings Incentive Match Plans for Employees) plans, SEP (Simplified Employee Pension) plans, profit-sharing plans, 401 (k) plans, and others

Learning the Lingo

The world of pensions has a language of its own. We'll help you make sense of it. For example, in this article we'll focus on tax qualified plans. These give you a tax break, and so they're usually most attractive to you. However, you should be aware that nonqualified plans that are not tax favored are also available to meet your retirement needs.

Do You Need a Plan?

Perhaps you already have an IRA. (If not, you should.) But the funds in your IRA may be insufficient to retire on, and you want to receive additional tax-favored treatment for money you contribute to a business-related retirement plan. Take a look at the advantages and disadvantages of tax qualified plans.

A tax-qualified plan is an agreement between the employer and its employees that complies with the requirements of the Internal Revenue Code. In basic plans, an employer can contribute 15% of the first $160,000 of each employee's salary up to $30,000.

As a business owner, you wear two hats you are an employer, but also an employee. As the employer, you provide the benefits of a tax-qualified plan to yourself as the employee. Under a tax-qualified plan, the benefits provided by you as the employer must benefit all employees. You as a business owner also gain tax advantages for your business.

Even if you're the sole employee, even if you have self-employed income from moonlighting while you have a job, or your business is unincorporated, a retirement plan is available. Such plans are commonly referred to as Keogh Plans. Except for certain prohibited transactions, similar rules apply to Keogh Plans and plans for larger enterprises.

For a retirement plan to work, you need money to put into it. While you will not be locked in to making contributions to some plans during bad financial years, you need to feel that you are at a stage in your business where you can make a commitment to finance the plan.

That said, it's important to start as early as possible. If you started at age 30 with a retirement plan, putting 10% of your income of $50,000 into a retirement plan every year, assuming a return on the investment of 10%, by age 60, you would have $1,243,000. But a delay of even a decade in getting started can make a huge difference. By waiting to begin retirement planning until age 40, your retirement plan would be only worth $396,900.

Sidebar: Pros and Cons of a Tax-Favored Plan

Advantages

A retirement plan could give you a competitive advantage over other businesses to attract and keep qualified employees.

As the employer, you receive a current tax deduction for all contributions to the plan. As an employee, you are not currently taxed on the contribution when it is made on your behalf, but only when you actually receive the money on your retirement, death, disability, or termination. Generally, when you receive the proceeds at the later date you have less income, and therefore pay a lesser tax rate on these distributions. Plus you can continue to defer this tax until age 70 1/2by not taking distributions.

The funds contributed by you as the business owner to the plan are held in a separate trust account. These assets may not be touched by the business, and are exempt from creditors of both your business and your employees. The funds in this tax-sheltered trust are to be invested by you as a "Trustee" of the retirement plan. All of the income generated by investment of these funds is also tax deferred. The trust will not pay any tax when the income is earned and the tax will be deferred until the investment income is actually distributed to you.

Disadvantages

You have to meet all the requirements of the Internal Revenue Code to receive tax-favored status. That prohibits you from contributing to your own account at a rate that discriminates against employees who are not owners of the company. Additionally, as an owner-employee, you will have to meet special requirements in order to maintain the plan's tax-favored status. And only a certain amount of contributions to the plan will be tax deductible.

Plans can be expensive to administer, and you will be required to file an annual form with the Internal Revenue Service. However, the expenses of administration and filing annual reports will be paid from the plan assets and not out of your business.

The Department of Labor requires that the Department be notified and, in some instances, employees be notified about certain plan provisions.

To ensure the tax-exempt status of your plan, you must file for approval from the Internal Revenue Service. The application form is complicated and takes a long time to process. (However, there are several types of plans available to you that do not require approval. These include volume submitter plans, prototype plans and SIMPLE plans.)