By Lee Schuh
Few entrepreneurs really think about preparing financially for retirement. Too many are depending on Social Security. Frankly, Social Security is only a safety net and not intended to be anything else. You are not going to have a very satisfactory retirement if Social Security is the major financial contributor.
When asked when to start planning for retirement, I answer, “At the start of your first job.” Time for saving is critical to the amount saved. I recommend entrepreneurs begin their retirement planning as soon as the company starts generating a profit. You can reduce high state and federal taxes on the income with a retirement plan, thereby enabling the government to do its fair share in helping the entrepreneur and maybe providing employees with a way to save for retirement.
There are numerous plans that provide a tax advantage. They are designed to fit the needs of the company based on its size, type of work force and ability to pay. There are also some complicated plans that do not defer taxes but provide the owner with substantial retirement benefits from retained earnings.
Administratively, the simplest for businesses are the aptly named SIMPLE plans that allow for employee savings and provide employers with a business tax deduction. It’s hard to build up a large retirement with these plans, though, as the funds are restricted to $12,500 (indexed) per year for those younger than 50 years old. The SEP plan requires a little more paperwork but is designed for small businesses wherein up to $53,000 (indexed) per person can be set aside each year. Both these plans are good if the owner wants the employees to benefit and is willing to put aside the small amounts authorized by the plans.
For larger businesses willing to take on more paperwork, profit-sharing plans are available that allow the company to avoid funding the plans in the occasional bad year. To supplement these plans in the nonfunded years, the taxpayer can use a Roth IRA. I recommend these plans for owners who intend to sell the business well before retirement age. The vested benefits go with the individual who leaves and the assets can be transferred to an IRA until a new business is off the ground and able to accept the transfer of the funds.
For owners intending to stay until retirement with companies that are generating a nice cash flow and good profits on a continuous basis, nothing beats the defined-benefit pension plan. There is a relatively large amount of administration required and a need to cover long-term employees. Generally, though, employees do not stay long enough to vest their pension benefits. The median number of years that wage and salary workers had been with their current employer was 4.6 years in January 2014, unchanged from January 2012, according to the U.S. Bureau of Labor Statistics.
Thus, only the most loyal of workers will be with you long enough to benefit from the pension plan. The pension allows for savings of over $200,000 (indexed) a year on a tax-deferred basis for the individual and a tax deduction for the business providing a luxurious retirement.
Since many entrepreneurs do not start their business until their 50s or fail to start a company retirement plan, the retirement savings can be supplemented with an IRA. There are three IRAs to supplement your savings: the traditional IRA, the post-tax IRA and the popular Roth IRA. Each allows for $5,500 (indexed) a year in savings with the traditional being tax-deferred funding. IRAs allow the use of funds for certain types of emergencies and have a wide choice of investments for the taxpayer.
The last type of plan is funded by retained earnings and is not tax-deductible for the company until the owner or employee pays taxes on it. While these nonqualified plans can be very complex, they can be quite beneficial for the owners and key employees.
Your financial adviser, enrolled retirement plan agent or tax preparer can provide more details and recommend the plan that’s best for you and your retirement. All you need to do now is make the appointment.
• Lee Schuh is a lecturer in the California Lutheran University School of Management.