Retirement Options

Retirement planning is a necessary and fundamental part of planning for the future. Furthermore, there is an abundance of retirement planning options available to taxpayers today. Contributing to a retirement plan makes sense for practically all taxpayers. It is one of the easiest and most powerful ways to reduce your overall tax burden. Far too many taxpayers miss out on this incredible opportunity and in doing so not only end up with less saved for retirement but also pay higher taxes, both equally negative consequences. Proper retirement tax planning can provide significant tax benefits today as well as in the future.

Small business owners and the self-employed overwhelmingly neglect to take advantage of the numerous planning options available exclusively to them. The Small Business Administration's Office of Advocacy reported that fewer than 2% of business owners had a Keogh (self-employed profit-sharing) plan, only 18% participated in a 401(k) plan, and more than nine million self-employed individuals do not have any retirement plan coverage.

Plans vary greatly and choosing the appropriate plan is a function of multiple factors. While all taxpayers have options available, there are plan specific rules and restrictions all taxpayers should be aware of to avoid possible pitfalls.

A SEP IRA, or Simplified Employee Pension Plan, is an easy, low cost option available to sole proprietors, partnerships, and corporations, (including S corporations). Simplified employee pensions are among the oldest varieties of retirement accounts designed specifically to appeal to small businesses. Contribution levels can change every year to meet business conditions and unlike the burdensome traditional 401(k) bearing complicated and costly administrative rules, SEPs are relatively simple to create and have no separate annual (Form 5500) filing requirement by the Internal Revenue Service. Essentially all that is required is to fill out some basic paperwork with a bank or a broker. The main drawback to this plan is that only employer contributions are allowed and the employer must make the same percentage contribution for all employees who have worked for the employer for three out of the last five years. Below are the key rules to know for the plan for 2011:

·        Maximum Employer Contributions: Smaller of $49,000 or 25% of participant's compensation or 20% of self-employment income for the 2011 tax year.

·        Maximum Deduction: Same as employer contributions.

·        Last Date for Contributions: Due date of employer's return (including extensions). This allows for the employer to receive the deduction in the tax year prior to when the actual payment to the plan takes place.

·        When To Set Up Plan: Any time up to the due date of employer's return (including extensions) making it extraordinarily flexible and tax advantageous to the taxpayer.

A SIMPLE-IRA is limited to employers with 100 or fewer employees (including self employed individuals) that do not maintain another retirement plan. The plan is relatively easy to set up and much like a 401(k) plan without complex nondiscrimination and "top-heavy" rules. Employees make salary reduction contributions to the SIMPLE-IRA and employers make certain mandatory (but modest) matching contributions. The plan must be offered to all employees who have earned $5,000 from their employer in the prior two years, and are reasonably expected to do the same in the current year. Below are the key rules to know for the plan for 2011:

·        Maximum Contribution: Unlike a SEP, SIMPLEs allow contributions of 100% of income. So, even with the lower contribution limits, a SIMPLE can be a better choice for self-employed people with lower incomes.

o  Employee contributions: Salary reduction contribution up to $11,500, $14,000 if age 50 or over.

o  Employer contributions: Either dollar-for-dollar matching contributions, up to 3% of employee's compensation, or fixed non-elective contributions of 2% of compensation.

·        Maximum Deduction: Same as maximum contributions.

·        Last Date for Contributions:

o  Employee contributions: By the end of the calendar year.

o  Employer contributions: Due date of employer's return (including extensions).

·        When To Set Up Plan: Any time between January 1 and October 1 of the calendar year. For a new employer coming into existence after October 1, as soon as administratively feasible.

Qualified plans fall under two categories, a defined benefit or defined contribution plan. Defined benefit plans are pension plans that promise to pay a fixed amount when participants retire; regardless of how well (or poorly) the plan has performed. The defined contribution plan type is currently the more widely used plan and our discussion will be limited to this type. The qualified plan rules are more complex than the SEP plan and SIMPLE plan rules. However, there are advantages to qualified plans, such as increased flexibility in designing plans, increased contribution and deduction limits in some cases, and tax-free borrowing from the plan in certain instances. When the plan is in operation, it is run by an individual or committee designated by the employer known as the "plan administrator." The plan administrator is responsible for the plan's day-to-day operation, including the interpretation of its provisions. For instance, the administrator typically applies the provisions of the plan to determine when an employee has satisfied the plan's eligibility rules, whether and when a participant is eligible for benefits, the amount and form of such benefits, and other matters. The plan is also subject to a separate annual (Form 5500) filing requirement by the Internal Revenue Service.

A 401(k) Plan allows employees to make pre-tax contributions; the employer can make matching contributions (and must do so if employees are automatically enrolled in the plan so that the plan is not considered discriminatory in favor of owners). A 401(k) plan can even be used by a self-employed individual who has no employees; the individual makes an "employee" contribution as well as any "employer" contribution.

Below are the key rules to know for 401(k) plans for 2011:

·        Maximum Contributions:

o  Employee Contributions: Elective deferral up to $16,500, $22,000 if age 50 or over.

o   Employer Contributions: Smaller of $49,000 or 100% of participant's compensation.

·        Maximum Deduction: 25% of all participants' compensation or 20% of net self-employment income.

·        Last Date for Contributions:

o  Employee Contributions: By the end of the calendar year.

o  Employer contributions: Due date of employer's return (including extensions).

·        When to Set Up Plan: By the end of the tax year.

Profit-Sharing Plans (often called "Keoghs" when used by self-employed individuals) allow employers to contribute a percentage of employee compensation to the plan. The same percentage used by the owner must be used for employees, so if the owner wants to contribute 10% of his earnings to the plan, he/she must contribute 10% of each participant's salary to the plan as well. The employer invests the contributions on behalf of participants whose retirement income depends on plan performance. In the past, profit-sharing plans restricted the employer's contributions to be made only out of current or accumulated profits. This is no longer required. An employer may now choose to make profit-sharing plan contributions from either current or accumulated profits, or both. This feature (plus the fact that, under this type of plan, the employer's annual obligation to make contributions may be made discretionary) allows these plans to be more responsive to an employer's business needs and can be a significant advantage when the company's needs and/or profitability fluctuate from year to year.

Below are the key rules to know for profit sharing plans for 2011:

·        Employer Contributions: Smaller of $49,000 or 100% of participant's compensation.

·        Maximum Deduction: 25% of all participants' compensation or 20% of net self-employment income.

·        Last Date for Contributions: Due date of employer's return (including extensions).

·        When to Set Up Plan: By the end of the tax year.

For all retirement plans discussed here, contributions and growth are tax-deferred until money is withdrawn. Withdrawals taken before age 59 1/2 face a 10% penalty plus tax, and annual withdrawals become mandatory at age 70 1/2.

We hope that this discussion has provided you with some basic background information that will help guide you in determining whether you or your company should adopt a retirement plan and, if so, what type of plan would be most appropriate. Please feel free to contact us for more information or to discuss your retirement options in greater detail.