Small Business Owners Need to Think Big

Physician's Money DigestAugust15 2004
Volume 11
Issue 15

Many self-employed small business ownersdon't have a company retirement plan.They complain that the choices are tooconfusing and the plans are too costly toset up and maintain. But small business owners havebetter options than they realize, financial planners say.In fact, establishing a company retirement plan is essentialto a small business' continued success.

Which plan you choose depends on many factors,including whether you want to help your employeeswith their retirements, how long you have before yourown retirement, what you currently have saved forretirement, and how much more money you'll need tosave for the retirement you envision. Small businessowners have the following options:

• Solo 401(k) plans. Tax law changes in 2001 madethis a major new option for business owners with noemployees other than a spouse or partner. Under a solo401(k), you can annually contribute up to $41,000 tothe retirement plan as a combination of employee deferralsand employer contributions. In addition, you cankick in another $3000 in "catch-up" contributions thisyear if you are age 50 or older.


• Simplified employee pension (SEP) plans. Easyand inexpensive to establish and maintain, SEPs are setup as individual employee retirement accounts but allowlarger contributions than standard IRAs. In 2004, anowner can contribute up to 25% of compensation or upto $41,000 (based on a maximum compensation of$205,000), whichever is less. Special calculationrules apply to self-employed individuals.

The major drawback of SEPs for some owners is thatthey must fund contributions for eligible employees atthe same rate they fund their own accounts. Moreover,employer contributions are immediately vested.Generally, owners must include employees if they are age21 or older, have worked 3 of the preceding 5 years forthem, and have earned at least $450 for the year.Employers can make eligibility less strict, though.

• Savings incentive match plan for employees(SIMPLE). Owners whose personal income from theirbusiness is modest—perhaps it's a side business—butwho still want to maximize retirement contributionsmay want to consider a SIMPLE. That's because thisretirement plan allows them to defer as much as 100%of their compensation up to $9000 in 2004 ($10,000 in2005), plus another $1500 if age 50 or older.

Unlike with SEPs, employees are responsible forfunding their SIMPLE accounts (again, set up as anIRA), but the owner must match employee contributions.Generally, they must match employee contributionsdollar-for-dollar up to 3% of the employee's pay.The employer can go as low as 1%, but for no morethan 2 of every 5 years. A third choice is to make a 2%nonelective contribution (up to $4100), in which casethe contribution must be made even if the participatingemployee doesn't contribute.

Eligible employees are those who have earned at least$5000 in any 2 preceding years and who are expected toearn at least that much in the current year—unless youchoose to have lower requirements. You can excludeemployees covered by a union agreement.


• Additional plans. Small-business owners haveother options, such as profit sharing and Keogh plans.Another consideration is a defined-benefit plan, whichwould allow a small-business owner who is late to thesavings game to quickly stash away large amounts ofmoney. Defined-benefit plans can be expensive toset up for small businesses and owners are actuariallycommitted to setting aside a certain amount regardlessof profits. But less-expensive versions, even for the self-employed,are surfacing. Run the numbers with yourfinancial planner to see which plan fits your needs.

This article has been produced by the Financial Planning Association(, which is the membership organizationfor the financial planning community.

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