Benefits that won’t break the bank: retirement plans needn’t be scary. Tax credits, low maintenance and favorable rules make them easy and economical benefits for you and your staff
Recent developments have made workplace retirement plans even more attractive for companies of all sizes, including sole proprietors, like many frame shop owners. Such plans can shelter money from business and personal taxes, while allowing owners and employees to save for the future. Plus, they’re a great way to attract and retain valuable employees.
The only problem is there are so many different options–SEPs, SIMPLE IRAs, Keoghs, 401(k)s, SAR-SEPs, etc. Which one is right for you and your flame shop? Well, it depends on how much emphasis you put on the following criteria:
* set-up time, record keeping and reporting;
* employee contributions (most plans for small businesses require employer contributions);
* contribution limits; and
* the option not to contribute in some years.
Each plan offers its own combination of features. See which one is right for you.
Plans and Features
The SEP or Simplified Employee Pension is one of the most common retirement plans for small businesses, and with good reason. It is the easiest plan to set up and maintain. It is the only plan that allows the employer to change his or her contribution level each year or to not contribute at all in some years. Plus, employers don’t have to contribute at all for employees with less than three years of service.
This simplicity and flexibility is very attractive to many small business owners, including picture framers. In fact, Carole Saucier, owner of Quality Frames & Art in Austin, Texas, liked it so much that she established a SEP for herself and two of her employees. She explained, “Business was good, and I thought it would make a good benefit for my staff and me.”
Saucier said it was easy to set up the plan. “You call the broker. They send you a little paperwork. You fill it out, send it back and that’s it.”
Saucier said business was slow in early 2002, so she didn’t think she was going to make any retirement plan contributions for the year, but holiday business was so good that her accountant told her to “spend some money before the end of the year or pay taxes,” so she contributed $5,000 to both employees’ accounts and deducted those contributions from her taxes. After that, it’s up to each employee to tell the investment company how to invest Saucier’s contribution.
Bottom line: A SEP is an IRA for small businesses, but you’re allowed to contribute up to $40,000 per employee, limited to 25 percent of their compensation.
Another popular plan is the SIMPLE, which stands for the Savings Incentive Match Plan for Employees. Ironically, the SIMPLE is a little more complicated than the SEP but still quite manageable for a small business. Plus, unlike the SEP, SIMPLE plans allow the employee to contribute up to $8,000 ($9,000 if age 50 or older).
The SIMPLE’s employer contribution rules are slightly more complicated. Each year, the employer must contribute three percent of compensation up to $8,000 ($9,000 if age 50 or older) for each participating employee. However, in two out of five years, you may reduce that contribution to as little as one percent for each participating employee.
Or you can contribute two percent each year for all eligible employees, whether they participate or not. An eligible employee is defined as one who earned at least $5,000 in at least two years prior to the contribution year. Like the SEP’s three-year waiting period, this stipulation helps to ensure some degree of employee loyalty before the employer has to provide such a valuable benefit.
Relatively new on the scene is the Individual 401(k) for “owner-only” businesses (i.e., companies that employ only the owner and his or her immediate family members, or companies that employ the owner and employees working less than 1,000 hours per year). This plan allows a self-employed person to contribute to his or her retirement account in two ways: an “employee contribution” of up to $12,000 and an “employer match” of up to 25 percent of their salary for a total contribution of no more than $40,000. The Individual 401(k) requires some additional recordkeeping and IRS reporting, but the high contribution limit could make it worthwhile for the right business.
Finally, the SAR-SEP–Salary Reduction SEP–is a retirement plan that itself has been retired. It still exists in companies that established their plans before 1997, but in most cases, it has been replaced by the SIMPLE.
Other options include Keogh plans (profit sharing or money purchase) and the traditional 401(k). The Keogh profit sharing plan is the most accessible of the three. It offers flexible annual contributions and an age-based feature that benefits the oldest, most highly compensated employee(s). And it allows for vesting–participants gradually gain ownership of funds over a period of up to six years. However, each of these plans is more complicated, time-intensive and costly than the SEP, SIMPLE and Individual 401(k). As a result, they are usually not desirable for small businesses.
To encourage employers to create workplace retirement plans, the IRS offers a 50-percent tax credit to businesses with 100 or fewer employees. In other words, for every dollar you spend on set-up, administration and employee education, the IRS allows you to subtract 50 cents from your tax bill that year. The credit is limited to $500 per year for the first three years of the plan, but in some cases, the business won’t incur any creditable expenses.
One caveat: Beware of hidden costs. Seemingly benevolent brokers offer “free” retirement plans, when, in fact, they skim excessive commissions and unnecessary fees from your investments and those of your employees. As a result, it might be more cost-effective to pay someone to set up your plan for you. However, if you go with a broker, ask him or her for a full accounting of the one-time and ongoing fees. That way, you can make an informed decision, and if you later notice an undisclosed fee, you can fight it.
A retirement plan is a powerful savings tool. You have the opportunity to provide financial security for yourself and your employees. However, like any tool, without proper instructions, it won’t be used properly or at all. So help yourself and your employees by learning how to make the most of your retirement plan. The investment company you use should provide you with educational materials or personal assistance, which can be worth its weight in gold.
For more information about the technical aspects of each plan, consult with a discount broker, independent financial advisor or IRS Publication 560: Retirement Plans for Small Business.
$o now you know which plan you want. But what about the investments inside the plan? Don’t worry. If you follow these five simple rules, you will do better than most investors, and may even top many professionals.
1 Most of a portfolio’s return (and risk)is determined by one thing–the mix between stocks and bonds. And that includes mutual funds that invest in stocks and bonds. Bottom line: The greater your investment in stocks or stock mutual funds, the greater your potential return and risk.
I can’t emphasize that enough. During the bull market of the late 1990s, investors were fearless, and most thought bonds were for the faint of heart. Well, in the last three years, most of those same people have fled to bonds, but not until they had sold their stocks well below where they’d bought them, That’s what I call a “get-poor-quick” scheme. So pick a mixture you can stick with through good times and bad. Even the youngest, most aggressive investor should put at least 20 percent in bonds.
2 Diversify! When one investment is rising, another might be falling. Since it’s impossible to predict these movements, it’s best to spread your “eggs” among various baskets (i.e., large and small companies, U.S. and international and growth and value).
3 Buy and hold. The information published by investment magazines and TV shows is not meant to make you rich. It is meant to sell more magazines and advertising. If month after month they published responsible advice–for example, buy a diversified portfolio of investments and hold onto it–they would quickly lose sub-scribers, viewers and money. In most cases, you should change your investments only when things about you change–your age, children, goals, job stability, etc.
4 Rebalance annually. Over time, gains in some investments and losses in others will result in a portfolio with undesirable risk or return levels. So reset your portfolio once a year to the mixture you chose in steps one and two. Do this by selling a portion of those investments that have risen in value and–with the proceeds–buying more of those investments that have fallen in value.
At first, selling winners and buying losers might seem counter intuitive, but it follows the most basic rule of investing–buy low and sell high. Furthermore, investments go in cycles, so winners eventually become losers, and vice versa. Again, since it’s impossible to predict these movements, it’s best to rebalance regularly.
5 Minimize your investment costs. Do this by avoiding “loads” (i.e., commissions or sales charges). Loaded mutual funds are unnecessary when there are thousands of excellent “no-load” funds available through discount brokers like Vanguard, Waterhouse and Schwab. The other way to minimize costs is to buy funds with low turnover. This means they obey rule #3–buy and hold. Mutual funds are required to publish this information, so if you can’t find it, just ask the investment company. Coincidentally, these two criteria are commonly found in my favorite type of mutual fund called index funds. When it comes time to pick the investments for your plan, ask the investment company if they offer no-load stock and bond index funds. If they don’t, take your valuable business elsewhere.
A former member of the art and framing industry, Dave Ressner is president of Ressner Financial Planning LLC, a fee-only financial advisory firm in St. Louis. He can be reached at Dave@RessnerFinancial.com or www.RessnerFinancial.com.
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