Retirement Planning For Small Business
With the e-commerce shake out just beginning and e-companies starting to lay off workers, we clearly see that the successful, remaining business web-based sites will fall into two, or maybe three, main categories.
First, are the content sites. The sites which provide useful articles and information. Second, are the application-based sites, with eBay.com being one of the best examples of an application-driven site. Third, are the "community" sites which bring like-minded people together.
Perhaps surprisingly, one small business areas which seems to benefit greatly from the Internet in all of the above categories is the area of retirement planning for small business owners.
More and more, information about small business retirement planing is becoming available over the Internet, and more and more companies are making it easier for small businesses to administer retirement plans cost effectively over the Internet. Just as online stock trading seems to have pushed down trading fees, so too, are 401(k) plans becoming more feasible for small business owners.
Here are some possible retirement planning strategies for small business owners:
First, and simplest, is just saving as much income as possible that your business generates. This money can be saved and invested via a standard brokerage account.
Many business owners depend upon the future sale of their business to generate their retirement funds. And, building, growing, and eventually selling a business is still one of the best ways to amass future wealth.
There are two reasons for this. One is that a successful, mid-sized business will probably be valued at a few times annual earnings and that is a nice chunk of change. Two, is that the sale of a business will probably be taxed at the lower capital gains tax rate. The big disadvantage is that you cannot know by how much your company will be valued in the future and competitive pressures could greatly devalue your business.
The above owners might also open an IRA account at a brokerage firm and contribute $2,000 a year. Over 30 or 35 years, such contributions, through compounding, really add up. To see how much your savings will grow into given various assumed rates of return, I refer you to the online savings calculator at Kiplinger.com.
The newer Roth IRA should also be considered. With the Roth IRA, initial contributions are taxed, but any amounts compounded to in the future are untaxed upon withdrawal. Because of this, Roth IRA's are usually seen as better choices for young investors who have many years until retirement.
With an IRA, however, money cannot be withdrawn without penalty before you reach age 59 1/2 unless there are special circumstances. Many successful business owners find they can afford to retire before that age. Yet, hopefully, you will live far beyond that age, and so should have money waiting for you when you get there! Take a few extra vacations, if nothing else! Also, retirement money in an IRA is somewhat safer from legal liability judgments.
In any case, do save some money outside tax-deferred retirement vehicles. Such money is readily available without penalty if needed. If you need to weather a bad business period, or need more capital to grow your company, this money is available.
The retirement strategies above involve no complications or special legal requirements. Any business owner with earned income can save money and contribute to an IRA.
However, an IRA really limits the amount of income which can be sheltered from income tax. When most people talk about retirement planning, they mean investing in vehicles or accounts offering some tax-advantages.
In these tax-advantaged accounts usually the money is contributed from pretax earnings and not taxed until withdrawn from the retirement vehicle. Usually, the money compounds tax-deferred or, sometimes, as in Roth IRA, compounds tax free.
For example, if you are in the 31% federal income tax bracket and, say, an 8% state income tax bracket, this means about 40 cents of every dollar you earn goes to taxes. Every dollar saved in a tax-deferred retirement account would only correspond to being able to save 60 cents in a non-tax-deferred account.
Tax-deferred money is taxed upon withdrawal from the retirement plan, but this money has had many years to compound tax free, and, often, upon retirement, you will be in a lower income tax bracket.
Because of the significant power of being able to grow your retirement money tax-free, many people want to invest as much of their retirement savings as they can in tax-deferred accounts. The government wants people to be secure in their old age and so offers this advantage in the form of many plans—IRA, SEP-IRA, Keogh, 401(k), etc.
Think of all of these plans as containers holding your investments. It doesn't matter if the investments sheltered are stocks, bonds, or mutual funds.
However, the government doesn't want to see people use these plans to become rich via tax-free investing. Because of this and the danger of Social Security being underfunded in the future, I would not be surprised to see future laws amended to heavily tax what the government considers to be excess money held in such accounts.
When forming a tax-advantaged retirement plan for your business, several points should be considered. How much money can be saved tax-deferred? What are the administrative costs involved in running the plan? How reliable and solid is the company holding your and your employee's money? What are the government regulations affecting the plan in question? How easily can the plan be terminated or changed to meet your changing needs?
The first and, I think, most crucial point is to distinguish between Defined Benefit and Defined Contribution plans. Defined Benefit plans fix a future payout amount for the retired employee. The amount saved at present must be sufficient to cover these future obligations. To do this demands actuarial estimates of a person's life, assumptions about what rate of return the pension investments will achieve, estimates of how long a given employee will work for your company and, in general, knowing which way the wind will blow. Such plans are to be avoided for the small business owner.
Traditional Defined Benefit pension plans are not good for small business owners because they obligate your company to future payout amounts and you cannot, with any certainty, be sure you are not acquiring a huge, future liability. Problems with funding a Defined Benefit plan may occur.
Defined Contribution plans do exactly what they say. They define the amounts that can be contributed. The ending amount an employee has at retirement is a function of how well his or her investments do. In one form or another, small business retirement plans should be Defined Contribution plans.
Unlike an IRA, small company retirement plans are complex enough that you should seek professional counsel before making a decision as to what plan is best for your company.
A Simplified Employee Pension IRA (SEP-IRA) is like an IRA on steroids for you and your employees. It can be used by sole proprietors, partnerships, and small corporations, including S-type corporations. The employer contributes up to 15% of the employee's compensation up to $24,000. It is subject to the same rules as an IRA.
Keoghs are popular for consultants and the self-employed. They are not used for small corporations. Profit Sharing Keogh plans allow contributions up to 13% of earned income. Do not lock yourself into a non-profit-sharing Keogh where you are forced to make regular contributions.
The Big Kahuna of retirement plans is the good old 401(k). 401(k)'s are defined contribution plans. A big advantage of having a 401(k) is that employees today are familiar with them and, often, expect them. Having a 401(k) will make your business a more desirable employer. This is worthwhile, especially in a tight labor market.
401(k)'s involve the most reporting requirements and are the most expensive to administer. Employees make contributions from their pretax earnings. The company may or may not choose to offer matching contributions. You must be careful that your plan doesn't favor "highly-compensated employees."
Some small business owners moan and groan about how they'd like a 401(k), but don't want to include all their employees. They want to save money for themselves, but are unwilling to do so for their employees. That says worlds about how they view their employees.
It can cost as little as $2,000 a year to administer a 401(k). And, I think we will see even greater cost reductions as administration becomes more and more Internet-based. Usually, there is a fixed annual fee and a small, per participant fee. 401(k) provider companies offer so-called "bundled plans," which handle all of the government reporting, etc.
Investment selection within the 401(k) plan is also an issue. Some argue businesses should offer only a few core, carefully-selected, mutual funds to prevent employees from making bad investment decisions. I would avoid high-expense mutual funds. And, it seems prudent to keep your employees' money at an established brokerage firm, such as Charles Schwab or Vanguard.
I've listed some resources below for small business owners considering starting a 401(k). These links are for information purposes only. I'm not specifically endorsing any of the companies.
Retirement planning at about.com has a list of many 401(k) providers. A great site to learn more about retirement planning issues in general.
discusses the advantages of 401(k)'s. Micro401k.com utilizes Charles Schwab and all monies go directly to Schwab. Expenses are listed on their web site.
Get401k.com gives more reasons for offering employees a 401(k). Has an online calculator for calculating their fees.
Impact 401(k) has a comparison of fees. From Principal Life Insurance Company.
401keasy.com has an online glossary of 401(k) terms.
Quicken has great information on 401(k)s and all other retirement plans.
Vanguard is the leader in low-cost mutual funds. Has an "interactive interview" to help you decide upon a company plan.
http://timyounkin.com has more information about 401(k)'s.
The United States Department of Labor has a somewhat interactive program to teach you about the various retirement plans.
Business-survival.com has a nice article about evaluating 401(k) providers.
Finally, you can learn more from the IRS.
has downloadable publications. Individual Retirement Arrangements: IRA and SEP covered in Publication 590. Retirement plans for small business (SEP and Keogh) are covered in Publication 560.