It might seem impossible right now, but sooner or later, you will retire. And so will your employees. The question is, will you, or they, be ready?
People make assumptions about retirement that can shortchange them when it’s time to slow down. Some think they can rely on Social Security. Others think they’ll be able to live on the equity from the family home after they sell it and move into a condo.
Or they assume they can retire on proceeds from the sale of their business.
Such assumptions leave a lot to chance. A retirement plan can help you take control of your own destiny, says Michael Bein, a consultant for Harris Investor Services Inc. in Chicago, Ill.
A choice of plans
Bein, who works with all types of businesses in the upper Midwest to set up retirement plans, observes that people are living a lot longer today. “When you retire, you have to plan to live through the age of 100, which means you’ve got to have a substantial cash balance built up to support yourself,” he says.
Then there are taxes. In the typical individual- or family-owned small business, profits all pass through to the owner and get declared on the personal income tax return. But a retirement plan is a kind of time machine: You take money you make now and, instead of paying income taxes on it now, transport it to the future. “These plans allow a business owner potentially to move money from the corporate ledger to the personal ledger in a tax-efficient way,” Bein says.
Today there are three basic approaches most small businesses can take: A Simplified Employee Pension plan (SEP), a Savings Incentive Match Plan for Employees (SIMPLE), or a 401(k) plan. Each has its benefits and drawbacks, depending on your personal and business situation, so before you plunge into one or the other, you should speak directly with a professional financial advisor.
SEP plans
The SEP plan is funded strictly by employers. It’s a common plan for people who are self-employed, but it’s also available if you have other people working for you. Note one thing: Employees don’t contribute to an SEP – only employers do. So if you decide to offer an SEP plan, you will make the financial contributions. Since it’s part of your employee-compensation package, remember to include it when you calculate their total compensation and your labor costs.
Contributions aren’t mandatory. Of course, most years you’ll want to make a contribution, or else what’s the point of having the plan? But if things get tight, you can hold off without any kind of penalty.
The money typically goes into an individual retirement account (IRA), and the investments are directed by the employee. That’s important, because you as the employer don’t want to have the legal fiduciary responsibility for the assets of the pension.
“Typically, the SEP IRA is a nice plan for smaller companies with 10 employees or fewer, or if there are three or four partners in the business,” Bein says.
SIMPLE plans
The SIMPLE plan is among the most popular, Bein says. The big difference from an SEP plan is that the SIMPLE is initially funded by employees.
“The SIMPLE IRA is really a terrific plan for a company that has fewer than 100 employees and is looking to add a retirement plan as a startup,” says Bein. In 2009, employees can contribute up to $11,500 of their income. Those 50 and over are allowed catch-up contributions of $2,500 more, plus the company match.
Employees can put 1 to 3 percent of their pre-tax pay into the SIMPLE. In any year that an employee puts in money, the employers must match 1, 2 or 3 percent of the employee’s salary.
One big benefit for employers is that, unlike the SEP, employees fund it themselves (except for the employer match). And an advantage over 401(k) plans is that they’re a lot cheaper to start up. “The cost to open up a SIMPLE IRA plan is anywhere from $10 to $15 per employee, whereas a 401(k) is easily $1,200 a year, plus $20 to $25 per employee. And there are many additional regulations on a 401(k) that are not on a SIMPLE IRA plan.”
401(k) plans
Despite their greater complexity and certain drawbacks, 401(k) plans have their place. “Going from a SIMPLE IRA to a 401(k) really depends on how well a business owner is doing and how much money they want to put away,” Bein explains.
The 401(k) plan allows much larger contributions. In 2009, account holders can put in $16,500 of their income; persons 50 or older can bank another $5,500; and a profit-sharing program can be attached that allows the company potentially to put an additional 25 percent of the employees’ income into the plan. “Between those three components in a 401(k) you can put away a total of $49,000, and if you’re 50 or above, $54,500,” Bein says.
Unlike the SIMPLE, owners do not have to match the employee’s contribution to the 401(k). There’s a catch, however: the Internal Revenue Service limits how much the highest-paid employees, typically the owner and top management, can put into their own account based on how much the rank-and-file contribute.
“So all of a sudden you’ve got this great 401(k) plan in place, and you’ve got people who are not participating, which in this economic environment is definitely the case,” says Bein. “Then the owners are unable to put very much money into it.”
A “Safe Harbor 401(k)” offers an out. If the employer gives every employee 3 percent of their salary up front to put in their own accounts, the highly paid people can max out their own contributions. But, as Bein observes, “A lot of businesses are not in the cash-flow situation where they can afford every year to put away 3 percent of every person’s salary.”
Professional help
If you’re going to set up a retirement plan (and you really should), don’t do it on your own. Look for objective, professional help from an attorney or accountant, and don’t settle for the first name you find in the Yellow Pages or on the Internet.
“You want to make sure you’re working with somebody who’s well-versed in different types of plans,” says Bein. “Ask them, ‘How many retirement plans do you work with right now?’ I run across businesses all the time that are in the wrong plan –blatantly in the wrong plan. It is important to find somebody who’s got some experience in working with these types of plans.”
When it comes to retirement, take time now to stop leaving your future, or your employees’ futures, to chance. A well-thought-out retirement plan can help put you more in control of your own retirement years.
