Q: I own a small decorating business and
I’ll be the first to admit that I don’t know anything about taxes or retirement
plans. I’d like to set up a 401(k) or an IRA or some other kind of retirement plan
for me and my three employees. What are the various retirement plan options available for
a small business owner and in your opinion, which would work best for me? -- Wanda S.
A: Wanda, I appreciate your confidence in my humble
opinion, but asking me for financial advice is like asking Donald Trump for a
recommendation on hair care products. I can tell you what works best for me and my
business, but you’ll need to do your homework and seek professional advice to figure
out what would work best for you. As a side note, I hear that Donald Trump is coming out
with his own line of hair care product soon to be called “Big Head.” The formula
is 1% mousse, 1% liquid nails, and 98% hot air. It should be a big seller among the high
brow, comb-over crowd.
Here’s my best advice on retirement plans: find
yourself a financial advisor (or financial planner) who is has experience working with
small businesses and have him or her explain the options available and make a
recommendation as to the type of plan best suited for you and your business.
When I say “financial advisor” I’m not
talking about your know-it-all brother-in-law or your accountant. I’m talking about a
broker or financial planner (or other licensed professional) who has a proven track record
of making his clients money and is an expert on IRAs, 401(k)s, mutual funds, etc.
The best way to find a good financial advisor is to ask for
referrals from your most successful friends and associates. Find the richest, stingiest
man in town and ask who his advisor is. Meet with several advisors, explain your
situation, and ask for their recommendations. You should also make sure the advisor is a
good fit for your personality and your business. If all goes well you will be doing
business with this person for many years to come, so make sure the relationship feels
comfortable to you and that you are confident in the advisor’s ability to manage your
money.
Let me give you a quick overview of a few of the retirement
plans available to small businesses so you at least have an idea of what’s out there
before you start your search for a good financial advisor.
As a small business you basically have three types of
retirement plans that you can take advantage of: the Self-Employed 401(k); the Simplified
Employee Pension Plan or SEP IRA, and the Savings Incentive Match Plan for Employees or
SIMPLE IRA. Each allows you to make pre-tax contributions to the plan, which lets you save
for retirement and lessen your taxable income by the amount of the contribution. Your
investments also grow tax-deferred until withdrawal.
A Self-Employed 401(k) is an option for self-employed
individuals or business owners with no employees other than a spouse.
The business can be a sole proprietorship, a partnership,
or a corporation, including S corps. You can make salary deferrals to this type of plan of
up to $14,000 for 2005.
Next is the Simplified Employee Pension Plan or SEP IRA.
A SEP is an option if you earn a self-employed income from
a full or part time business, even if you are covered by a retirement plan at your
full-time job. A SEP allows you to contribute up to 25% of earned income, up to $41,000
for 2004 and $42,000 for 2005.
My preferred type of retirement plan is the Savings
Incentive Match Plan for Employees or SIMPLE IRA.
The SIMPLE IRA was created to make it easier for small
businesses with 100 or fewer employees to offer a tax-advantaged, company sponsored
retirement plan.
With a SIMPLE IRA you and your eligible employees may
contribute up to 3% of earned income (with a maximum contribution of $10,000) on a pre-tax
basis to individual SIMPLE IRAs. You must deduct Social Security and Medicaid from your
gross income, but you can then make your SIMPLE IRA contribution before other taxes are
levied, effectively lowering your taxable income.
As the employer you must make “matching” or
“non-elective” contributions into your employees’ SIMPLE IRA accounts.
Matching contributions means that the business matches the elective deferral contributions
made by employees. For example, if the employee opts to contribute 3% of his salary to the
plan, the employer must match the 3% contribution.
At first you might cringe at matching your employees’
contributions, but as the business owner and an employee yourself this can be great news.
As an employee of your own business you can contribute up to $10,000 to your SIMPLE IRA
and the business can then match your contribution dollar-for-dollar, which means that you
can put up to $20,000 in tax free dollars into the plan per year. The cost of the
contributions is also deductible as a business expense.
The non-elective contribution option requires that the
company contribute 2% of every employee’s earned income to the plan on the
employee’s behalf regardless of whether or not the employee contributes to the plan
himself. For 2005 the maximum contribution you would be required to make is $4,200.
Like a traditional IRA, you can withdraw money from a
SIMPLE IRA at any time; however distributions within the first two years of participation
are subject to higher early withdrawal penalties than traditional IRAs or Roth IRAs.
Withdrawals within the first two years are subject to a 25% early withdrawal penalty.
Withdrawals taken after the first two years are subject to a 10% early withdrawal penalty.
As the employer, the advantages of a SIMPLE IRA include:
company contributions to the plan are tax deductible as a business expense; plan documents
are simple and easy to administer; administration costs are low; and there is no
government reporting required by the employer.
The advantages of a SIMPLE IRA for your employees include:
contributions are immediately 100% vested; contributions and earnings are tax-deferred
until withdrawal; employees can contribute 100% of earned income up to $10,000 for 2005;
and employees can direct their own investments within the IRA.
This is a complex topic and I’ve just tipped the
iceberg here, but hopefully this will give you enough information to get the investment
ball rolling.
Here’s to your success! |
