Many small business owners scrimp and save and invest everything they have in their business. If they work hard and avoid disasters, the business grows and they eventually sell their business for a lot of money. But this strategy has some obvious pitfalls. Despite their best efforts, the business might not grow. After years of hard work, the business may not fetch a large sales price or any sales price. It is difficult to predict what might happen to a business 30 or more years down the road. Relying on a business to be the owner’s sole retirement asset is very risky.
As a business owner you need to start thinking of yourself first. Spending money on employees or assets to increase business capacity can be a good thing, maybe even a necessary thing. But what if it doesn’t pan out? What do you do 30 or more years form now if your business is worthless or unsellable?
A good idea is to protect yourself and your retirement by starting to put away money now in a qualified retirement plan or IRA. Qualified retirement plans offer many benefits including tax deductions for the contribution made by the business, tax deferral on the amounts you contribute, tax deferred growth of the investments in your plan account and protection of these assets from business and personal creditors.
Qualified plans you should consider include profit sharing plans and 401(k) plans. Contributions to a profit sharing plan are typically discretionary, although under a safe harbor plan you can avoid the discrimination-testing requirements if the plan provides for a mandatory 3% of compensation employer contribution. Voluntary contributions by employees to 401(k) plans can be made on a pre-tax or post-tax basis. The pre-tax contributions reduce current taxable income and grow tax free, but are taxable when received by the employee at retirement. The post-tax (Roth type) contributions would be subject to tax currently, but would grow tax free and would be tax free when received by the employee at retirement. There are annual limits on the amounts that can be contributed to a 401(k) plan by an employee. In 2014, the limits are the lesser of: (1) $17,500 ($23,500 if the employee is 50 years old or older); or (2) 100% of compensation.
There are different types of retirement plans. Some of these plans use techniques such as cross-testing, age-weighting and/or social security integration to allocate more of the employer contribution to the business owners.
Don’t get so caught up in running and growing your business that you forget to put something away for retirement. If you have any questions about retirement plan options, please contact me at Jsenney@pselaw.com or 937-223-1130.