Retirement plans are for small businesses, too

By Barbara Floyd, AAMS

A tax-qualified retirement plan offers employees an attractive means of saving for retirement and is an effective way for employers to get tax deductions and possible credits.

Unfortunately, small businesses don't always offer their employees any retirement plan at all due to the common misconception that such plans come with high costs and heavy administrative demands. Instead, employers may encourage their employees to establish individual retirement accounts (IRAs).

But IRAs alone aren't always enough to help these employees retire comfortably, and small businesses run the risk of losing employees to larger businesses which offer more attractive benefits packages.

To attract and retain valuable employees, many small businesses may want to consider offering employees a simplified employee pension (SEP) IRA, SIMPLE IRA or profit-sharing plan. These plans are relatively simple for the employer to establish and operate, and they need not overextend the resources of a small business.

Through 2006, small businesses that adopt a new plan may be eligible to receive up to a $500 credit for administrative and retirement education expenses. The credit is available for plan expenses (including retirement education) incurred for the first three plan years. Employees enjoy a vehicle for tax-deferred growth of assets and are provided with a tool to help them achieve retirement security.

The SEP IRA is popular in the small business community because employer contributions are fully discretionary each year and employers may take a tax deduction for the amount contributed on behalf of each employee. The contribution, if any, is not taxable to the participants until withdrawn. The self-directed SEP IRA offers employees the ability to accumulate more assets than possible through a traditional IRA and to choose investments that meet their specific retirement needs.

The SIMPLE IRA, designed for companies with 100 or fewer employees, is a salary deferral plan structured to eliminate many of the complex administrative requirements often associated with 401(k) plans. The SIMPLE plan allows for employee salary deferral contributions of up to the lesser of $10,000 (for 2005) or earned income, made on a pre-tax basis. The required employer contribution can take the form of either a 3 percent match or a 2 percent non-elective contribution. While the burden of funding the plan is shared by employer and employee, the employer gets a tax deduction for the entire amount contributed on behalf of each employee. Investment earnings accumulate tax-deferred until distributed from the plan.

Individuals who have reached age 50 by the end of the plan year are allowed a "catch-up" contribution to their SIMPLE IRA account. An additional $2,000 (for 2005) may be deferred into their account once the $10,000 limit has been reached. This additional amount will increase to $2,500 in 2006, to be indexed for inflation thereafter.

The profit-sharing plan is a qualified retirement plan that allows for discretionary tax-deductible contributions of up to 25 percent of total compensation paid to all eligible employees. Annual contributions on behalf of any individual can be up to the lesser of 100 percent of eligible compensation or $42,000 (indexed for inflation). The employer makes all contributions and the percentage contributed can vary from year to year.

With this plan, the employer retains the flexibility of excluding some part-time workers while the employee enjoys an employer-funded benefit plan that offers the possibility to accumulate significantly more assets on a tax-deferred basis than through a traditional IRA.

As you can see, there are many options for small business owners looking to provide a tax-deferred, employer-sponsored qualified plan. By establishing a retirement plan, you can make a dramatic difference in tomorrow's standard of living for yourself and your employees.

Barbara Floyd, AAMS, is a financial advisor of Legg Mason Wood Walker, Inc., a diversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc., and SIPC.

The foregoing information was prepared from sources believed to be reliable but is not guaranteed as to accuracy and is not a complete summary or statement of all available data. Please consult a professional advisor prior to implementing any of the strategies discussed.

Contact this Author: < Barbara Floyd >

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