Close-Up: Retirement Plans

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n.

Retirement Plan: A project of definite purpose for when you are withdrawn from or no longer occupied with your business or profession.

Some physicians believe that they are never going to completely retire. For others, the time when they can separate themselves from their life's work can't come fast enough. Either way, it's critical to develop a savings and investing plan designed to carry you through those golden years. And if you're self-employed, own a small business, or run a professional practice, it is your responsibility to make your own retirement savings arrangements.

In addition, as the owner of a small practice, you may be in a position to create a cost-effective retirement plan for your employees. The benefits are twofold. First, plan contributions you make for yourself help to reduce your taxable income. Second, contributions made on behalf of your employees are generally deductible as a business expense.

Three of the more popular tax-advantaged retirement plans are simplified employee pensions (SEPs), simple IRAs, and Keogh plans.

Overview of Options

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Writing in (Harper Business; 2000), Stephen Pollan explains that an SEP is like a high-performance IRA, allowing you to contribute significantly more of your earnings than you can with a conventional IRA. If you own a small practice, you can set up an SEP for yourself and your employees. The same percentage must be contributed for all employees in the practice and contributions are federal tax deductible. SEPs are easy to set up and are available from brokerage firms, mutual fund companies, and banks.

Simple IRA plans are similar to SEPs in that salary deferral contributions reduce taxable income and account growth is tax-deferred until the money is withdrawn. However, unlike many other retirement plans, a simple IRA has no required level of participation. Eligible employees can choose how much, and if, they wish to contribute to their simple IRA.

Their downside:

Keogh plans, Pollan notes, are one of the best ways for the self-employed individual with an average-to-large income to accelerate retirement savings. Unlike SEPs and simple IRAs, they're not simple. There are different types of Keoghs to choose from (eg, profit sharing, money-purchase, and defined-benefit Keoghs), each designed to accommodate a different financial situation. The formulas used to calculate your contributions can be challenging. Unless you have proficiency with numbers, you'll want your accountant to lend a hand.

Plan Comparisons

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How do these three plans stack up against each other? A side-by-side comparison offered by the magazine helps to sort things out.

Are employer contributions required? They are with simple IRA plans. With SEP plans, employers may vary contributions each year and even skip a year. The same is true with Keoghs, in which, depending on the type of Keogh plan you choose, contributions may skip a year, vary, or remain fixed.

• Do employees contribute? They don't with Keogh or SEP plans. With simple IRAs, employees choose if and how much to contribute. For 2004, the maximum salary deferral is $9000, or $10,500 for employees aged 50 and older.

What is the maximum employer contribution? For both SEP and Keogh plans in tax year 2004, it is the lesser of 25% of compensation or $41,000. For simple IRAs, there are two options. With employer matching, it's a dollar-for-dollar match on salary deferrals, up to the lesser of 3% of a participant's compensation or $9000 ($10,500 for employees aged 50 and older). With employer nonelective, it's up to 2% of each eligible employee's compensation.

• What is the vesting schedule? With SEP and simple IRA plans, all contributions are immediately vested 100%. With Keogh plans, employers may require employees to work up to 6 years to become fully vested.

Are there plan set-up and employer contribution deadlines? Yes. For Keogh plans, the set-up deadline is December 31, while the contribution deadline is the same as that for tax filing, which is usually April 15. With SEP plans, both set-up and contribution deadlines are the same as the tax-filing deadline. For simple IRAs, the set-up deadline is October 1 of each calendar year, but employer contributions can be made until April 15.

• What are the eligibility requirements? For SEP plans, an employee must be at least age 21, have been employed in 3 of the past 5 years, and have earned at least $450 in the past year. For simple IRAs, an employee must have earned $5000 in any 2 previous calendar years and be expected to earn at least $5000 in the current year. For Keoghs, the minimum age is 21 and the individual must be employed for at least 2 years.

Whatever plan you choose, keep in mind that it's important to maximize your contributions. A plan's tax-advantaged status will benefit you now and its tax-deferred growth will allow you to reap benefits in years to come.

Pop Quiz

1) An example of a tax-advantaged retirement plan for a self-employed or small business owner is a

• Simple IRA plan
• All of the above

2) With an SEP plan, the percentage contributed for all employees must be

• 20% of their salary
• The same

3) Among SEP, simple IRA, and Keogh, which plan does not require employees to participate?

• Simple IRA
• All of the above

4) In which of the three plans are employees immediately 100% vested?

• Simple IRA
• SEP and Simple IRA

5) Which plan allows employers to vary contributions from year to year?

• SEP and Simple IRA
• Simple IRA and Keogh

Answers: 1) d; 2) d; 3) b; 4) d; 5) c.