• Our Firm
• Our Services
• Contact

Retirement Planning Tips for the Self-Employed

As we discussed in my last column SIMPLE plans — Savings Incentive Match Plans for Employees of Small Employers — allow employees to defer, pretax, up to $10,000 ($12,500 if 50 or over by year-end) in 2006. The employer then must match such deferrals, dollar for dollar, up to three percent of compensation. Alternatively, the employer may choose to make a two percent contribution for all eligible employees, whether or not they defer. A special rule allows the matching contribution to be limited to one percent of compensation during two years of any five-year period. Special notice requirements apply to SIMPLE plans.

The beauty of SEPs and SIMPLEs is the lack of required administration. With each of these arrangements the employer is NOT sponsoring a qualified plan subject to the significant reporting requirements such plans entail. In each case, most of the required reporting is taken care of by the custodian of the funds. Additionally, the requirement that the plans be permanent in nature is not imposed on these plans. Conversely, one of the disadvantages of such arrangements is the required full and immediate vesting of all contributions.

Profit-sharing plans can be useful where the plan sponsor wishes to impose a vesting schedule or where the required coverage would not be significantly different from SEP or SIMPLE. Dependent on age demographics, profit-sharing plans can sometimes be designed whereby allocations approaching $44,000 can be achieved for high earners, with allocations for the non-owner employees as low as five percent.

Often the desired leverage comes with the addition of a 401(k) arrangement to the profit-sharing plan. Many new 401(k) plans are designed using one of the currently available "safe harbors". Under these safe harbors, no discrimination testing is required for the 401(k) deferrals if the employer provides a fully vested contribution of either (1) three percent of compensation to all participants, or (2) a matching contribution of 100 percent to the extent elective deferrals do not exceed three percent of compensation, and an additional 50 percent to the extent elective deferrals exceed three percent of compensation but do not exceed five percent of compensation (elective deferrals in excess of five percent need not be matched). A more generous matching scheme may be used.

Participants may defer up to $15,000 of their compensation into a 401(k) plan for 2006 ($20,000 for those who will attain age 50 before December 31). The use of elective deferrals to reach the $44,000 limit ($49,000 for those aged 50 by year-end) can often lower the required employer contributions for non-owner employees.

Defined benefit plans are most useful in one participant scenarios, but can also be useful in the professional setting. With high-income earners in their 50s, such plans can sometimes create deductible contributions in the $150,000 range or higher. Of course, the cost for providing benefits to employees, if there are any, must be considered.

Often a combination of a defined benefit plan with a profit-sharing plan (with or without a 401(k) plan based on the facts) can provide the most leverage. There are certain deductibility issues that can arise, but with the right employee mix such an arrangement can be very attractive. The following is an example of a recently designed defined benefit/profit-sharing combination:

In conclusion, there are many different possibilities when designing a retirement plan for your business owner clients. One size does not fit all. The facts and circumstances of each case will dictate what is appropriate.