Trying to research small business pension or retirement plan options? It's tricky, right? The alternatives and acronyms quickly overwhelm a person. Making matters worse, you've got a bunch of vendors--banks, financial services firms, mutual fund managers and so forth--begging for your business and touting their offer as the obvious best option.
Fortunately, you enjoy wonderful easy pension options for your business. These easy options are usually available regardless of whether you operate as a sole proprietorship, partnership, limited liability company or corporation. And for many small business owners, the easy options also often represent the best value.
Easy Option #1: A Traditional Individual Retirement Account
To start, don't overlook the traditional individual retirement account. No matter what your family income, if neither you nor your spouse are covered by some other qualified retirement plan, you can deduct contributions to a traditional IRA. Typically, neither the business nor the individual pay fees or pay only modest fees to have an IRA in place.
Regular annual contributions to a traditional IRA grow large over time. A $5,000 annual contribution (the standard amount allowed in 2008) made over 35 years grows to more than $550,000 after adjusting for inflation. (I'm assuming you can earn a six percent real, or adjusted for inflation, rate of return in this scenario and the others that follow.)
That $550,000 IRA balance is actually a pretty good ending account balance--enough for many business owners' retirements if they've also paid off a mortgage and qualified for social security. And remember that married couples can often double the ending value amount by doubling the annual contributions.
In summary, then, a traditional IRA shouldn't be overlooked--especially if you and any employees want to save only a few thousand dollars a year.
Easy Option #2: A Simple-IRA
If you or employees want to save more money than is possible with a traditional IRA, you can often for free or almost free set up a Simple-IRA plan for the business.
Essentially, a Simple-IRA works like a "lite" version of a 401(k). With a Simple-IRA, employees and the business owner can contribute up to $10,500 ($13,000 if aged 50 or older) of their earned income to the Simple-IRA account. The employer annually matches the employee's contributions, too, with a standard 3% of salary contribution.
If someone making $50,000 contributes the maximum $10,500 amount to the Simple-IRA and the employer contributes another $1,500 (three percent of the $50,000), the employee accumulates roughly $1.2 million in savings after 35 years. Again, I've adjusted for inflation by using a six percent after-inflation return, or real return.
Easy Option #3: A SEP-IRA
One other inexpensive yet powerful small business pension plan option deserves mention.
If you're a one-person business or employees usually don't stay around for very long, you may want to consider the SEP-IRA option. With a SEP-IRA, you can contribute up to 20% of your business profits in the case of a sole proprietorship or partnership or up to 25% of your wages in the case of a corporation, including an S corporation.
To give you an example of this, assume your sole proprietorship makes $100,000 each year, in this case, you can contribute $20,000 (20% of the $100,000) to a SEP-IRA account. Or, as another example, assume your S corporation pays you $80,000 in wages. In this case, you can contribute $20,000 (25% of the $80,000) to a SEP-IRA account.
Over 35 years, after adjusting for inflation, a $20,000 a year SEP-IRA contribution grows to roughly $2.2 million dollars. Here again, by the way, I've used a 6% annual investment return in my calculations.
As is the case with both the traditional IRA and Simple-IRA options, a SEP-IRA typically costs the business owner nothing or next to nothing. You won't get burdened with expensive set up fees or annual administration costs.
However, while you can make large annual contributions to SEP-IRA accounts (up to roughly $46,000), the plans don't work for every small business. And here's why: You must cover all employees who have been employed by you for more than three years and who are over the age of 21.
SEP-IRAs, then, are probably most attractive to one-person businesses-such as consultants and tradespeople-that don't need to worry ever about making the SEP-IRA contribution for employees.
Moving Forward
I've been pretty birds-eye in my discussions in this article, so you may have more questions. You should be able get answers about all of these retirement savings from just about any mutual fund company, bank or stock broker. Note, by the way, that the annual contribution limits typically get adjusted for inflation.
Copyright (c) 2008 Stephen Nelson
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Small business CPA Stephen L. Nelson wrote the bestseller QuickBooks for Dummies. He also publishes the S Corporation Explained and Do-it-yourself Incorporation Kit web sites. Nelson holds an MBA in finance from the University of Washington and an MS in taxation from Golden Gate University.
Disclaimer: All information on this site is provided for informational purposes only! By no means is any
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