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Choosing a Retirement Plan for a Small Business

In the not-so-distant past, small-business owners were at a disadvantage when it came to qualified retirement plans. But the “playing field” has been evened out in recent years. For instance, now a small business or sole proprietorship can use one of the following four types of plans.

1. Simplified Employee Pensions (SEPs): A SEP is generally exempt from the reporting requirements for other qualified plans. With a SEP, you must make contributions on behalf of all employees age 21 or older who have worked for a company during three out of the last five years (absent any union agreement).

For 2006, you can make a deductible contribution up to the lesser of 25% of compensation or $44,000 (the defined contribution plan limit). The maximum amount of compensation taken into account for this purpose is $220,000. Contributions are discretionary, so you are not locked into a figure for the year.

As with other qualified plans, distributions must begin by April 1 of the year following the year in which you turn age 70½. If you take an early distribution, you will trigger a 10% tax penalty, unless an exception applies.

2. Savings Incentive Match Plans for Employees (SIMPLEs): A SIMPLE is only available to employers with 100 or fewer employees. Like SEPs, SIMPLEs are exempt from most reporting rules. Key difference: A company cannot contribute to a SIMPLE in a year in which it maintains another qualified plan.

For 2006, an employee may elect to contribute up to $10,000 to the plan. If you are age 50 or older, you can add a “catch-up contribution” of $2,500. As a general rule, the employer may provide matching elective contributions subject to nondiscrimination rules. The rules for mandatory distributions after turning age 70½ also apply to SIMPLEs (but the 10% penalty tax is increased to 25% for early withdrawals within the first two years).

3. Keogh plans: To set up a Keogh plan, you must be a self-employed individual. It does not matter if you have any other employees or not. The amount you can contribute annually depends on whether the plan is a defined contribution or defined benefit plan. For 2006, the maximum amount you may contribute and deduct for a defined contribution Keogh is the lesser of 20% of earned income or $44,000.

With a defined benefit Keogh, contributions are actuarially computed. You can provide an annual retirement benefit of the lesser of 100% of earned income for the three highest paid years or a specific dollar amount adjusted for inflation ($175,000 for 2006). The rules for distributions from qualified retirement also apply.

4. Solo 401(k) plans: A 401(k) plan generally combines elective deferrals with matching contributions by the employer. The contributions are made on a pretax basis. The rules for contributions and distributions from qualified plans generally apply to solo 401(k) plans.

Assuming you are the only employee, you don't have to worry about nondiscrimination rules. There is an annual dollar cap on the elective deferrals that can be made to a solo 401(k) plan. For 2006, the limit is $15,000 (plus a catch-up contribution of $5,000 if you are age 50 or older). Employer contributions may be made up to the limits for defined contribution plans.

The choices can be bewildering for the uninformed. Don't hesitate to contact your professional advisers for more details.

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	[ return to list ] Choosing a Retirement Plan for a Small Business In the not-so-distant past, small-business owners were at a disadvantage when it came to qualified retirement plans. But the “playing field” has been evened out in recent years. For instance, now a small business or sole proprietorship can use one of the following four types of plans. 1. Simplified Employee Pensions (SEPs): A SEP is generally exempt from the reporting requirements for other qualified plans. With a SEP, you must make contributions on behalf of all employees age 21 or older who have worked for a company during three out of the last five years (absent any union agreement). For 2006, you can make a deductible contribution up to the lesser of 25% of compensation or $44,000 (the defined contribution plan limit). The maximum amount of compensation taken into account for this purpose is $220,000. Contributions are discretionary, so you are not locked into a figure for the year. As with other qualified plans, distributions must begin by April 1 of the year following the year in which you turn age 70½. If you take an early distribution, you will trigger a 10% tax penalty, unless an exception applies. 2. Savings Incentive Match Plans for Employees (SIMPLEs): A SIMPLE is only available to employers with 100 or fewer employees. Like SEPs, SIMPLEs are exempt from most reporting rules. Key difference: A company cannot contribute to a SIMPLE in a year in which it maintains another qualified plan. For 2006, an employee may elect to contribute up to $10,000 to the plan. If you are age 50 or older, you can add a “catch-up contribution” of $2,500. As a general rule, the employer may provide matching elective contributions subject to nondiscrimination rules. The rules for mandatory distributions after turning age 70½ also apply to SIMPLEs (but the 10% penalty tax is increased to 25% for early withdrawals within the first two years). 3. Keogh plans: To set up a Keogh plan, you must be a self-employed individual. It does not matter if you have any other employees or not. The amount you can contribute annually depends on whether the plan is a defined contribution or defined benefit plan. For 2006, the maximum amount you may contribute and deduct for a defined contribution Keogh is the lesser of 20% of earned income or $44,000. With a defined benefit Keogh, contributions are actuarially computed. You can provide an annual retirement benefit of the lesser of 100% of earned income for the three highest paid years or a specific dollar amount adjusted for inflation ($175,000 for 2006). The rules for distributions from qualified retirement also apply. 4. Solo 401(k) plans: A 401(k) plan generally combines elective deferrals with matching contributions by the employer. The contributions are made on a pretax basis. The rules for contributions and distributions from qualified plans generally apply to solo 401(k) plans. Assuming you are the only employee, you don't have to worry about nondiscrimination rules. There is an annual dollar cap on the elective deferrals that can be made to a solo 401(k) plan. For 2006, the limit is $15,000 (plus a catch-up contribution of $5,000 if you are age 50 or older). Employer contributions may be made up to the limits for defined contribution plans. The choices can be bewildering for the uninformed. Don't hesitate to contact your professional advisers for more details. [ return to list ]
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