Establishing the Right Retirement Plan for You and Your Business

By: Tina D’Agata (Aug, 2012)

The path to retirement security is establishing the right plan for you and your business.  Starting a retirement plan can be easier than most business owners think.  By establishing a plan you will begin to secure your own retirement in addition to giving your employees a mechanism to save for their future.  Experts estimate that individuals will need anywhere between 70 – 90% of their pre-retirement income to maintain their current standard of living when they retire.  Are you prepared for this?

Retirement plan savings is a great way to supplement your income in retirement.  Below is a chart that shows the power of being able to invest in a pre-tax plan in comparison to a taxable savings account. 

 

After-Tax
Savings Plan

Employer-Sponsored
Retirement Plan

Tax-Deferred
Advantage

10 years

$26,568

$32,776

+23.37%

20 years

$70,855

$92,408

+30.42%

30 years

$144,679

$200,903

+38.38%

The above chart assumes a $200 monthly contribution and a 15% tax bracket. The investment is compounded monthly and earns a 6% annual rate of return.  Information derived from the Department of Labor website.

Retirement plans offer many benefits for both the employer and the employees.

Employer Advantages

-          A means to attract and retain key employees
-          Generates tax credits for establishing a plan
-          Significant tax advantages
-          Flexible plan options

Employee Advantages

-          Reduced taxes as federal income taxes and many state income taxes are not paid on deferred amount
-          Assets in plan grow tax free

Once you decide that offering a retirement plan makes sense for you and your business the next step is choosing the plan that best suits your needs.  To do this you need to consider what your objectives are.  Following are a few quick questions to ask yourself:

1.)    Am I looking to contribute more than $5,000 of my own money?
2.)    Do I want to allow my employees to contribute their own money?
3.)    Can I afford guaranteeing a minimum employer contribution of 3% of salary for eligible employees?
4.)    Do I want the flexibility to change the employer contribution from year to year based on the profits of my business?

Your answers to the above questions can guide you in selecting the appropriate plan.  Below is a comparison of the different type of retirement plan options:

IRA's (Traditional, Nondeductible or Roth)

  • Inexpensive to set up (can be done directly with financial institution-bank or brokerage house).
  • $5,000 maximum (extra $1,000 catch up if 50 and over)

 SEP Plans (Simplified Employee Pension)

  • Inexpensive to set up (can be done directly with financial institution).
  • All contributions are Employer contributions.
  • All contributions are discretionary so there is no obligation to fund in any given year.
  • Must make employees eligible after they have worked for you in 3 of the last five years.  No hours worked requirement.
  • Maximum employer contribution is 25% of compensation.  Maximum compensation that can be used is $250,000, and maximum annual contribution for an individual is $50,000.
  • All contributions are deposited directly into IRA accounts for eligible employees so there is no control after the money is deposited.  100% vesting is mandatory.
  • No annual filing requirement. Minimal or no annual cost to administer.

SIMPLE IRA Plans

  • Inexpensive to set up (can be done directly with financial institution)
  • Must make employees eligible if they have earned at least $5,000 in compensation during any two preceding years and are reasonably expected to earn $5,000 this year.
  • Maximum employee contribution for 2012 is $11,500, ($5,500 less than 401(k)).
  • Catch up contributions of $2,500 allowed for employees 50 and over.
  • Employer must commit to making either a 2% of pay contribution for all eligible employees or a 3% of pay matching contribution on behalf of those employees that contribute up to 3% of their own pay.
  • Employer may not contribute more than the above stated amounts.
  • Must be established prior to October 1st and no other plan can be in existence during the year.
  • No annual filing.  Minimal or no annual "outside" cost to administer.

401(k) Profit Sharing Plan

  • More costly to set up.  Annual IRS filing required.
  • Eligibility is typically 1 year of service and age 21 or older but you can have a minimum number of hours worked or end of year employment requirement in order to share in employer contributions.
  • More flexibility for both employee and employer contributions.
     - Employee ability to contribute.  Maximum of $17,000 in 2012.
     - Employer Match (can be fixed or discretionary),
     - Employer discretionary Profit Sharing.
  • Maximum deductible employer contribution is 25% of total eligible compensation.  Maximum compensation per person that can be used is $250,000, and maximum annual contribution for any individual is $50,000 (combination of both employer and employee contributions).
  • Catch up contributions of $5,500 allowed for employees 50 and over making their maximum $55,500.
  • More costly to administer annually but more employer discretion and control over employees.

The key to a successful retirement plan is establishing a plan that not only helps you save for retirement but also allows you to continue to operate your business or personal life in an efficient manner.  It is imperative that you don’t over commit yourself or your business from a cash flow perspective.  We recommend that retirement plan contributions be made with dollars that you are hoping that you won’t need until your retirement years.

If you have any questions on establishing or maintaining a retirement plan please do not hesitate to call Dermody, Burke & Brown’s retirement plan administration group.

 

The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.

 

 

 

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