How Business Owners Can Take Control of Taxes, their Own Retirement ( WSJ)

MAY 11, 2010, 4:12 P.M. ET Retirement-Plan Options for Business Owners By BARBARA WELTMAN

Many small-business owners believe that their businesses will furnish a comfortable retirement for them. As golden years approach, they anticipate selling their nest egg and living off the proceeds.

This may account for the fact that retirement plans are severely underutilized by business owners. The Small Business Administration's Office of Advocacy reported that fewer than 2% of business owners had a Keogh (self-employed profit-sharing) plan, only 18% participated in a 401(k) plan, and more than nine million self-employed individuals do not have any retirement plan coverage.
Business owners who rely on the sale of their businesses for retirement income may be disappointed. Unfortunately, not all businesses can be sold at a profit, as evidenced by the thousands of companies forced to close during the recent recession (including many that had been operating profitably for decades).

Here's a better strategy for ensuring that you'll have sufficient retirement income to supplement Social Security benefits: Make annual contributions to a qualified retirement plan. It's a tax-advantaged savings method: contributions go into a qualified retirement plan on a tax-deductible basis; annual earnings are tax-deferred; and benefits are taxed only when and to the extent that distributions are made.

Choosing a Plan
A number of retirement plans can be used by small businesses. Keep in mind, if you want to use plans other than traditional or ROTH IRAs, you'll have to include any employees in the plan (with some exceptions).

Here are the best retirement-plan options:

SIMPLE-IRAs. This type of plan is limited to employers with 100 or fewer employees. Much like 401(k) plans, employees make salary reduction contributions to the SIMPLE-IRA and employers make certain mandatory (but modest) matching contributions.

SEPs. This option is for self-employed individuals as well as companies of any size. The plan is funded entirely by employer contributions.

401(k) plans. As in the case of large corporations, small businesses can allow employees to make pre-tax contributions to the plan; the employer can make matching contributions (and must do so if employees are automatically enrolled in the plan so that the plan is not considered discriminatory in favor of owners). A 401(k) plan can even be used by a self-employed individual who has no employees; the individual makes an "employee" contribution as well as any "employer" contribution.

Profit-sharing plans. These plans (often called "Keoghs" when used by self-employed individuals) allow employers to contribute a percentage of employee compensation to the plan. The same percentage used by the owner must be used for employees, so if the owner wants to contribute 10% of his earnings to the plan, he/she must contribute 10% of each participant's salary to the plan as well. The employer invests the contributions on behalf of participants whose retirement income depends on plan performance.

Defined benefit plans. These are pension plans that promise to pay a fixed amount when participants retire, regardless of how well (or poorly) the plan has performed.

Db(k) plans. This is a type of hybrid plan that debuted in 2010. It combines a small pension (funded by the employer) with a 401(k)-type feature (funded by employees with certain employer matching contributions). Because the IRS has yet to issue guidance, these plans are not yet commercially available, but hopefully will be a viable option for 2011.

Deciding Your Goals
Which plan you choose depends on your situation and what you hope to accomplish. Some factors to consider:

Contribution limits. The tax law sets limits on how much can be added annually to a particular type of plan. Owners with little or no staff who are primarily concerned with savings for their own retirement and maximizing tax deductions for contributions might want to use a 401(k) or defined benefit plan. The latter is especially useful for older professionals because sizable contributions are usually needed to meet promised pension targets.

Contribution costs. If the business is profitable and wants to benefit not only its owner but also its staff, contribution costs can be high; contributions within the limits allowed by law are tax deductible. Businesses that want to provide a plan for staff but can't afford sizable contributions might opt for plans that shift most of the cost to employees, such as SIMPLE-IRAs and 401(k)s.

Administrative burdens. Generally, the business must file an annual return for a qualified retirement plan, which usually entails additional accounting fees. However, no annual filing is required for SIMPLE-IRAs and SEPs, so these plans are the least burdensome from an administrative point of view.

Other costs. Expect to pay consulting fees if working with a benefits expert to select or design a custom plan. For defined benefit plans, you typically need to pay an actuary to determine your annual contribution (generally, that's the amount needed to meet the promised pension, given the expected retirement date, earnings in the plan, and other factors). Also, annual premiums must be paid to the Pension Benefit Guaranty Corporation for defined benefit plans, and there are bonding requirements.

Other Considerations
In addition to the personal goals of the owner, there are other compelling reasons to offer a retirement plan for staff.

Recruitment tool. Offering a retirement plan is a way for small businesses to compete with large corporations for talent in the jobs market.

Tax savings. Making contributions to a retirement plan may help to save more taxes than merely the savings resulting from the contributions. The deduction for employer contributions reduces income, which may help owners to avoid higher tax brackets as well as the additional Medicare taxes scheduled to take effect in 2013.

Flexible borrowing. Certain retirement plans, such as profit-sharing plans and 401(k) plans, can allow participants, including owners, to borrow from their accounts as needs arise.

Business owners can find more information about retirement plans in IRS Publication 560. As always, discuss the use of qualified retirement plans with your tax or financial advisor to determine the best plan to select.


About the Author
Barbara Weltman is an attorney who has written several books, including "J.K. Lasser's Small Business Taxes" and "The Complete Idiot's Guide to Starting a Home-Based Business." She publishes "Idea of the Day" and monthly e-newsletter "Big Ideas for Small Business" at www.barbaraweltman.com, and hosts the "Build Your Business" radio show.