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Employee Benefits
Rainy Day Retirement Plan Option
By Mark Sullivan
President and Chief Investment Officer, Seacoast Asset Management, Inc.
401(k) plans- not just for big business any more!
In the past, many owner-only small businesses have viewed 401(k) plans as too expensive or impractical in comparison to other retirement plans. However, if you operate an owner-only small business, a 401(k) plan may have become more attractive. That’s because tax laws have brought sweeping changes to 401(k) plans, such as:
higher deductible contribution limits
catch-up provisions
loan provisions for owners
ability to consolidate multiple retirement accounts
We are talking about the Owner-Only 401(k).
Owner-Only 401(k) - When you establish an owner-only 401(k), you can put up to 20 or 25 percent of your compensation into a profit-sharing account, (20% if Sole Proprietor or Partner, 25% if Corporation), plus $15,000 in 2006 as 401(k) contributions. If you’re 50 or older, you can even put an extra $5,000 into your 401(k). (However, total annual contributions cannot exceed the lesser of 100% of compensation or $44,000 if you’re under age 50, or $49,000 if you’re 50 or older.) All contributions will grow tax-deferred.
"Rainy Day" Loan Provisions - Though many plans offer little or no tax-free access, the Owner-Only Plan offers the opportunity to borrow up to 50% of the account balance or $50,000, whichever is less, tax free and penalty free, and take up to five years to pay it back. And the interest charged, usually at preferred rates, is paid back into the plan for the owner’s benefit. Though borrowing from retirement plans advisedly should be considered a last resort, it can be a very valuable option, particularly to a new business owner at the beginning stages of building a business, or one with large swings in cash flows.
Increasing amounts - Furthermore, both the 401(k) and 50-and-over "catch-up" limits will be increasing over the next several years, so you’ll be able to put away even more money for retirement.
Tax advantages - Not only are contributions tax-deductible, but they accumulate tax deferred until taken as a distribution from the plan. Taxable distributions are subject to ordinary income tax, and if taken prior to age 59 ½, may also be subject to a 10% federal income tax penalty.
Consolidation - You can transfer most retirement plan assets, such as profit sharing, money-purchase plans and even IRAs— into your Owner-Only 401(k).
Vesting - All contributions are immediately 100% vested.
Low cost - Due to its focus on one-person businesses, these programs are often less administratively burdensome because they do not require extensive nondiscrimination testing. Therefore, the program can be provided at a lower cost than most traditional 401(k) plans.
No Complex Administration - Plans that only cover a business owner and their spouse are not required to file an annual report with the U.S. Department of Labor until aggregate plan assets exceed $100,000. Once the plan reaches $100,000, the plan is only required to file IRS form 5500-EZ.
Who fits the profile? Small businesses operated by the owner and his or her spouse, including incorporated businesses such as S and C corporations and unincorporated businesses such as Partnerships and Sole Proprietorships.
Exclusions: Some employees may generally be excluded from coverage, including: employees under the age of 21, employees working less than 1,000 hours, Union employees and Non-resident aliens.
Who does NOT fit the profile? Most businesses with non-related employees or businesses that may experience rapid growth in the future.
Find out more: To find out more about the pros and cons of the Owner-Only 401(k) plan and whether it is right for your business, and if so, which companies are the best providers and why, contact your independent financial advisor.
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Article reprinted by permission. Unauthorized reproduction of content prohibited.
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