As an entrepreneur, you have done your homework, put in many late nights and weekends, and now after investing all your heart and soul, your business is growing by leaps and bounds. Wasn't that the grand scheme, to be your own boss, create your own wealth and play by your own rules? Or was it really only a part of the grand scheme? There is another part that is equally important….retirement planning and saving. If your idea of retirement planning and saving is a matter of throwing a random amount of money into a passbook savings account now and then, your grand scheme is really not so grand.
It has been my experience when working with entrepreneurs, that so much time and effort has been exhausted in creating and building the business, but much less thought has gone into building and cultivating a retirement nest egg.
Here are some facts that you should know in creating and cultivating a retirement savings plan:
1. Retirement is expensive. If you are going to be able to maintain your standard of living, your "nest egg" should provide you with retirement income that is 70-90 percent of your pre-retirement earnings.
2. Remember that the IRS wants its share. Unlike qualified retirement plan contributions, earnings on contributions to savings accounts are taxable today. With inflation and taxes, your buying power from your savings account is less. Therefore, your retirement savings should be invested in the most tax-advantaged way.
3. Segregate emergency funds from retirement savings or the retirement cupboard will be bare sooner rather than later. Set aside 3-6 months of earnings for use in emergencies. This allows your retirement savings to remain in tact and on track.
4. Don't put all of your "retirement eggs" in one basket. In other words, diversify and use a variety of savings/investment vehicles to accumulate and shelter wealth. The three most advantageous savings vehicles in order are the employer-sponsored qualified retirement plan, which allows for tax-deferred growth. Second, are the individual retirement accounts, such as the traditional IRA and the Roth IRA. Finally, are taxable investment accounts and savings accounts.
An employer-sponsored retirement plan gives you, the business owner, several personal and professional advantages. You save toward your personal retirement goals; but as the employer, you also save payroll and employment taxes that do not need to be paid on employee's pre-tax contributions. Also, if there is an employer-matching contribution, you receive a tax deduction for the matched contributions.
Here are several of the most common small-business retirement plan options. All are defined-contribution rather than defined-benefit plans; benefits are based on how much you'll be putting in rather than withdrawing.
SEP-IRA (Simplified Employee Pension Plans)-Considered one of the easiest retirement plans to establish and maintain. They are designed for small business owners and the self-employed and are 100% employer funded. The employer can contribute up to 25% of employee compensation or $40,000, whichever is less. (Contribution limits are indexed annually). The percentage of your compensation that you contribute each year can vary (based on maximum limits) or can be skipped all together when you don't want to contribute. Please be aware that employer contributions are fully vested once made and the percentage contributed to your own SEP-IRA must also be contributed to all eligible employees.
SIMPLEs (Savings Incentive Match Plan for Employees) - There are two types of SIMPLE plans, a SIMPLE-IRA and a SIMPLE 401K. They are similar, but vary by filing requirements, the ability to take out loans or withdrawals, and the employer-matching guidelines. SIMPLEs are for small businesses (100 or fewer employees) and allows for pre-tax employee contributions up to $7000 (indexed annually). Employers must also make matching contributions dollar-for-dollar from 1 to 3% of employee's compensation. SIMPLEs are ideal for business owners who want a plan with limited administrative burdens and would like employees to share in the responsibility of saving for retirement.
Keoghs - Suitable for unincorporated self-employed individuals who want higher annual contribution limits than SEP-IRAs and SIMPLEs. There are two types of Keoghs-profit sharing and money purchase pension plans.
A Profit Sharing Keogh allows for contributions up to 100% of eligible compensation or $40,000, whichever is less. Only 25% of eligible compensation is deductible (contributions are based on a compensation cap that is indexed annually for inflation. The cap for 2002 is $200,000). Once the plan is in place, contribution rates can vary from year to year or can be skipped all together, although the plan must be maintained with the intention of making regular contributions. This type of plan is suitable for businesses where income fluctuates year to year.
A Money Purchase Pension Plan allows for contributions up to 100% of eligible compensation or $40,000, whichever is less. Only 25% of eligible compensation is deductible (contributions are based on a compensation cap that is indexed annually for inflation. The cap for 2002 is $200,000). Once this plan is in place, contributions are mandatory each year at a predetermined percentage. This type of plan is best suited for businesses that have stable income and can assure the ability to make the same contribution percentage each year.
Employers also have the ability to offer a paired plan, a profit sharing and money purchase pension plan together. The total combined amount that can be contributed is 100% of compensation or $40,000 whichever is less; although only 25% of eligible compensation is deductible (contributions are based on a compensation cap that is indexed annually for inflation. The cap for 2002 is $200,000). The paired plan is best suited for an employer who wants a low mandatory contribution percentage as well as discretion over making larger contributions.
401(k) s -This type of plan is often more expensive and complicated to administer than other retirement plans, but offers more options. 401(k)s are designed to be funded primarily by the employees. Matching contributions are not required, but many businesses opt to contribute as a staff enticement and retention tool. Employers can utilize a vesting schedule for employer matching contributions to encourage employees to stay at the company until they are 100% vested. Employee contributions are always 100% vested. As of 2002, the maximum allowable contribution amount is $11,000 (indexed annually).
So far we have discussed employer-sponsored retirement plans, but let's not forget about individual retirement accounts (IRA's). Once you have contributed the maximum amount to the company's plan, additional savings up to $3000 for 2002, can be done with a Traditional IRA or Roth IRA. A traditional IRA allows for an upfront tax deduction (with certain limitations) and tax-deferral on all earnings, while a Roth IRA allows for after-tax contributions and earnings to be withdrawn tax-free (with certain limitation.) Which IRA account is best suited for you, is determined by your adjusted gross income (AGI) and if your company offers an employer-sponsored retirement plan.
Nevertheless, IRAs offer another effective savings vehicles for retirement.
If there is anything that you take from this, I would hope it would be just how important it is to include a retirement savings and investment program into your grand scheme. Again, it cost almost as much to live after retirement as it does now and the longer you wait the more overwhelming and uncertain it becomes. The following are two scenarios that look at savings strategies for individuals who began saving at different ages.
Entrepreneur #1 Entrepreneur #2 Present Age: 40 55 Desired Retirement Age: 65 65 Desired Monthly Income: $5,000 $5,000 # of years retirement payments should last: 25 25 Estimated After-Tax Rate of Return: 6.5% 6.5% Estimated Inflation Rate: 3.0% 3.0% Desired Annual Increase after retirement: 3.0% 3.0% Monthly Savings Amount needed $2,254.09 $5,444.33
Based on the illustration, I pose the following questions; will you be ready when it is time to retire? What are you doing now to secure your retirement needs? If these questions have made you sit up and take notice, please call me to discuss creating a savings strategy best suited for you.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.