If you start researching small business pension options,
the alternatives quickly overwhelm. Banks, financial
planners, insurance agents and many others clamor for your
attention and offer up what they tout as the obvious best
option.
Fortunately, and perhaps surprisingly, you can create easy
pension options for your small business. These easy options
are usually available regardless of whether you operate as
a sole proprietorship, partnership, limited liability
company or corporation. And for many small business owners,
the easy options also often represent the best value.
Easy Option #1: A Traditional Individual Retirement Account
To start, don't overlook the traditional individual
retirement account. No matter what your income, as long as
neither you nor your spouse are covered by some other
qualified retirement plan, you can setup and deduct
contributions to a traditional individual retirement
account. Typically, neither the business nor the individual
pay fees or pay only modest fees to have an IRA in place.
Regular annual contributions to a traditional IRA grow
large over time. A $5,000 annual contribution (the standard
amount allowed in 2008) made over 35 years grows to more
than $550,000 after adjusting for inflation. (I'm assuming
you earn an after-inflation 6% rate of return in this
scenario and the others that follow.)
That $550,000 IRA balance is actually a pretty good ending
account balance--enough for many business owners'
retirements if they've also paid off a mortgage and
qualified for social security. And remember that married
couples can often double the ending value amount by
doubling the annual contributions.
In summary, then, a traditional IRA shouldn't be
overlooked--especially if you and any employees want to
save only a few thousand dollars a year.
Easy Option #2: A Simple-IRA
If you or employees want to save more money than is
possible with a traditional IRA, you can often for free or
almost free set up a Simple-IRA plan for the business.
Essentially, a Simple-IRA works like a "lite" version of a
401(k). With a Simple-IRA, employees and the business owner
can contribute up to $10,500 ($13,000 if aged 50 or older)
of their earned income to the Simple-IRA account. The
employer typically matches the contributions, too, with a
standard three-percent-of-salary contribution.
If someone making $50,000 contributes the maximum $10,500
amount to the Simple-IRA and the employer contributes
another $1,500 (three percent of the $50,000), the employee
accumulates roughly $1.2 million in savings after 35 years.
Again, I've adjusted for inflation and used a 6%
after-inflation return.
Easy Option #3: A SEP-IRA
One other inexpensive yet powerful small business pension
plan option deserves mention.
If you're a one-person business or employees usually don't
stay around for very long, you may want to consider the
SEP-IRA option. With a SEP-IRA, you can contribute up to
20% of your business profits in the case of a sole
proprietorship or partnership or up to 25% of your wages in
the case of a corporation, including an S corporation.
To give you an example of this, assume your sole
proprietorship makes $100,000 each year, in this case, you
can contribute $20,000 (20% of the $100,000) to a SEP-IRA
account. Or, as another example, assume your S corporation
pays you $80,000 in wages. In this case, you can contribute
$20,000 (25% of the $80,000) to a SEP-IRA account.
Over 35 years, after adjusting for inflation, a $20,000 a
year SEP-IRA contribution grows to roughly $2.2 million
dollars. Here again, by the way, I've used a 6% annual
investment return in my calculations.
Like the traditional IRA and Simple-IRA option, a SEP-IRA
usually costs the business owner nothing or next to
nothing. You won't get burdened with expensive set up fees
or annual administration costs.
However, while you can make large annual contributions to
SEP-IRA accounts (up to roughly $46,000), the plans don't
work for every small business. And here's why: You must
cover all employees who have been employed by you for more
than three years and who are over the age of 21.
SEP-IRAs, then, are probably most attractive to one-person
businesses-such as consultants and tradespeople-that don't
need to worry ever about making the SEP-IRA contribution
for employees.
Moving Forward
I've been pretty birds-eye in my discussions in this
article, so you may have more questions. You should be able
get answers about all of these retirement savings from just
about any mutual fund company, bank or stock broker. Note,
too, that the contribution amounts allowed regularly get
adjusted for inflation.
----------------------------------------------------
Small business CPA Stephen L. Nelson wrote the bestseller
QuickBooks for Dummies. He also publishes the
http://www.scorporationsexplained.com and
http://www.fasteasyincorporationkits.com web sites. Nelson
holds an MBA in finance from the University of Washington
and an MS in taxation from Golden Gate University.
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