Retirement Plans for Today's Small Business Owner 
When it comes to Retirement Plans, there are Individual Plans, such as a Traditional or Roth IRA, and there are Employer-Sponsored Plans, such as Defined Contribution or Defined Benefit Plans. Each of these plans are limited as to the amount you can put into the plan (the Contribution), or some cases, what is projected that you can take out of the plan (the Benefit). Employer-Sponsored Plans could be one of two types, or a combination thereof.
Defined Contribution Plans – These plans are usually based on the company’s earnings, age of the participant and/or wages earned by the participant. Some Defined Contribution plans offer employees the ability to contribute to Elective Deferrals. All contributions are limited according to IRS regulations and must be made on behalf of qualified employees as the plan dictates.
Examples of Defined Contribution Plans include Money Purchase Pension Plans, 401(k) Plans, 403(b) Plans, Profit Sharing Plans, Simplified Employee Plans (SEP), Simple IRA Plans and Stock Bonus Plans.
A Defined Contribution Plan:
- May or may not an have other retirement plans (depending on the Plan you select)
- Can be a business of any size
- May or may not need to file a Form 5500 with a Schedule B annually (depending on the Plan you select)
Defined Benefit Plans - Different than the Defined Contribution Plan, the “Benefit” is defined in a Defined Benefit Plan, and contributions are based on an actuarial determination of what the participants' retirement benefits should be, not on profits. The amount that can be contributed is based on a variety of factors, including the age and current wages of the participant, assumed interest rate, mortality tables, and more.
Defined Benefit pension plans currently do not have contribution limits when determining the annual contribution amount necessary, but for 2011 the maximum annual retirement benefit permitted under a defined benefit plan cannot exceed the lesser of 100% of the participant’s average compensation for his/her highest 3 consecutive calendar years or $195,000. For 2012, the annual benefit cannot exceed the lessor of 100% of the participant’s average compensation for his/her highest 3 consecutive calendar years or $200,000
A Defined Benefit Plan:
- Can have other retirement plans
- Can be a business of any size
- Must file a Form 5500 with a Schedule B annually
- Have an enrolled actuary determine the funding levels and sign the Schedule B
- Benefits cannot be retroactively decreased
Hybrid Plans could be a combination of the plans mentioned above, but special IRS rules and limits do apply.
Between the two types of Employer-Sponsored Plans available, Defined Benefit Plans are typically more expensive to administer, due to IRS regulations and special formulas associated with the actuarial calculations for each participant. On the other hand, especially in this low interest-rate environment, for a business owner over the age of 50, this type of plan could prove to be the best plan for greatest annual tax deductible contributions before retirement.
Let’s take Joe, for example, a 50-year old small businessman, with net self-employment or salaried income of $120,000 annually. The first year the plan is established, approximately 33 percent of his compensation, or $40,000, could be contributed to a Defined Benefit plan and written off as a tax deduction. Anticipated increases in necessary funding for the Defined Benefit plan would allow future tax-deductible contributions of more than 50 percent of compensation. In fact, by age 65, Joe’s tax deductible contributions could reach 100 percent of pay because the older the owner-participant when the plan is started, the greater the contribution.
Defined benefit plans are usually best for those within 20 years of retirement, because they allow larger annual contributions than defined contribution plans. When the Participant does retire, he/she can begin taking distributions from the plan or roll it over into an IRA Rollover account for a more flexible distribution schedule.
It is important to point out that similar to the majority of the Defined Contribution Plans mentioned above, the Defined Benefit Plan cannot discriminate; therefore if an employee qualifies to be a participant under the plan, contributions based on the same formula as an owner-participant must be made for them as well.
When deciding which plan is best for you and your company, you must consider a variety of factors, including:
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How many employees does the company have
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The ages of those employees
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How much is the company are able, or willing, to put into the plan
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Do you want your annual contribution amount to be a flexible or a fixed percentage
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Do you want your employees to be able to contribute with Elective Deferrals
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Do you have company stock that could be used as a contribution
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The cost to administer the plan
To read more about Employer-Sponsored Retirement Plans, you can read IRS Publication 560 (Retirement Plans for Small Business) or visit the IRS Website at http://www.irs.gov.
When it comes to your Retirement Plan, give us a call. We can assist you in comparing the costs and the benefits of each plan and to determine which plan may be best for you and your employees.