While 2010 isn't over yet, it's not too early to think about setting up a qualified retirement plan for 2011. Getting an early start is especially important if you have employees. This will give you time to select the plan that best meets your business and retirement-plan goals. It will also give employees an opportunity to decide whether to participate and how much of their wages to contribute if you choose the type of plan based on employee contributions, such a 401(k) plan.
Why have a retirement plan?
A qualified retirement plan allows owners to shelter company profits while saving for their personal retirement. It also creates a valued employee benefit to attract and retain good workers.
Of course, there is a cost for these benefits. The company must include employees in the plan, and to a greater or lesser extent, make contributions on their behalf on a nondiscriminatory basis; the plan cannot be limited to owners and key employees. There is a cost not only for company contributions, but also for administrative plan-related activities, such as filing annual information returns if required.
If a small business of less than 100 employees sets up a qualified retirement plan, it can take a tax credit of half of certain administrative costs (such as educating employees about the plan) up to a credit of $500 per year for the first three years of the plan. However, to claim the credit, the plan must cover at least one person who is not an owner or owner's spouse.
Which plan is right for you?
There are many types of qualified retirement plans to choose from. The following are the key types of plans popular with small businesses (discussed in IRS Publication 560, Retirement Plans for Small Business), and their features and advantages. There are a number of variations on these basic types of plans.
These plans are funded solely by employer contributions, enabling businesses to offset their profits by deductions for contributions on behalf of employees. If a business isn't profitable, it doesn't have to make contributions.
Simplified employee pensions (SEPs)
These are a variation on profit-sharing plans and are widely used by small businesses. The advantages of these plans are no annual filings of information returns for the plans and the fact that they can be set up and funded as late as the extended due date of the return for the year to which they relate (e.g., a 2011 plan of a business owner with a filing extension can be set up and funded by October 15, 2012).
These plans are funded by employee contributions made on an elective deferral basis (employees agree to add part of their salary and aren't taxed on this contribution). Employers may want or be required to contribute to employee accounts; employer contributions are deductible by the business.
These function much like 401(k) plans, but have lower limits on the amount that employees can contribute. Also, if they are set up as SIMPLE IRAs, there is no annual information reporting as there is for 401(k) plans.
Defined benefit plans
This is a pension funded by employer contributions. The plan promises to pay a set benefit at retirement, and contributions are actuarially determined to meet this benefit promise. For businesses with owners that are highly paid professionals and few or no other employees, this plan can provide significant retirement benefits and tax-sheltering, all or most of which go to the owners.
What's new for 2011?
The IRS has released the limits on contributions and benefits that will apply to qualified retirement plans in 2011; because of low inflation, they are the same limits that applied in 2010. Key figures of note:
- Maximum contribution to profit-sharing and SEP plans: $49,000
- Maximum benefits provided by defined benefit (pension) plans: $195,000
- Maximum amount of compensation taken into account in figuring contributions and benefits: $245,000
- Maximum elective deferral to a 401(k) plan: $16,500 (plus an additional $5,500 for those at least 50 years old by the end of 2011)
- Maximum elective deferral to a SIMPLE plan: $11,500 (plus an additional $2,500 for those at least 50 years old by the end of 2011)
What to do now?
It's wise to meet with a tax adviser to discuss your plan options and which type of plan works best for your personal situation next year. For example, if the company has a small staff, you may want to use an automatic 401(k) plan so that you, as the owner, can maximize your personal contributions. With this type of plan, employees are automatically included with a set contribution amount unless they opt out or change their contribution amount; the company must make certain minimum contributions to avoid certain complexity. The sooner you make plans, the sooner you and your staff can begin to save for retirement on a tax-advantaged basis.
Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser’s Small Business Taxes and The Complete Idiot’s Guide to Starting a Home-Based Business, and trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® at www.barbaraweltman.com and host of Build Your Business radio. Follow her on Twitter @BarbaraWeltman.