December 1999/January 2000

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Retirement planning: part three

Barry and Howard
PBS Tax and Bookeeping Service

Concluding our series on retirement planning, we previously talked about the need for retirement planning and two types of plans - the traditional IRA and the Roth IRA. Now we'll look at further options for small business owners.

The retirement plans that are easy to administer usually have low limits on how much the owner can contribute and costs can increase because they may require employee participation. If you want a plan that will allow you to contribute heavily to your own retirement (while excluding other employees), and if you are much older than the other employees, there are two options. You can have either a defined-contribution or a defined-benefit plan designed to allow you to contribute heavily on your own behalf. However, you need to be aware that the IRS can disqualify these plans for not following the strict rules for administration. Consequently, these plans can be expensive.

The type of plan you choose is dependent on whether you are using it as a recruitment and retention tool for employees or you are using it mainly for your own retirement benefits. Do you feel a duty to provide retirement for employees? Your tax advisor can help you make choices.

The following is a synopsis of some types of plans:

THE SEP-IRA
The simplified employee pension IRA is a plan that allows you to set aside up to 13 percent of net income up to $24,000. If you have employees older than 21 who earn more than $400, they must be included in the plan.

THE KEOGH PLAN
If your business has a predictable cash flow, you might consider a money purchase plan that requires a fixed contribution of up to 20 percent for you and 25 percent for employees. If you are new in business or have a cash flow that is unreliable, you may consider a profit-sharing plan. The contribution up to $30,000 is 13 percent for the owner and 15 percent for the employees.

THE SIMPLE PLAN
The Simple Plan is a savings incentive match plan for employees that allows contributions of 100 percent of earned income up to $6,000. Even if an employee chooses not to participate, the owner is required to contribute 2 percent of the employee's earnings. For participating employees, the match is 3 percent. Two out of every five years, the match can be reduced to 1 percent. A potential downside is that employees earning $5,000 and more must be included and can earn matching funds. The big benefit of the Simple Plan is that if you don't have employees, you can put $6,000 away each year in this easy-to-administer plan.

THE DEFINED CONTRIBUTION PLAN
Plans such as these can be skewed so that only the owner (and not the employees) can be eligible. However, since they include 401-K plans, they are usually more expensive to set up and administer. On the plus side, you can contribute up to 20 percent of income with a maximum of $30,000 per year.

THE DEFINED BENEFIT PLAN
This plan is also expensive to set up and administer, but more than $30,000 per year can be contributed. Contributions are based on actuarial assumptions about how much should be set aside to provide the pension amount. This means an owner who is older can put in more for himself, and minimal amounts for younger workers. Since this plan pays a set amount in retirement (based on salary and years of service), it's possible to provide a retirement income up to 100 percent of salary to a maximum of $120,000. The defined contribution and benefit plans are obviously for very high earners and is used by owner-operators in extremely rare cases.

In addition, there are Education IRAs limited to $500 per year per beneficiary. Contributions do not count against the limit for other IRAs and are not deductible.

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