In today’s uncertain economy, sellers can’t be as choosy as in the “good old days.” Business owners and homeowners generally have to settle for less if they want to sell their business or a home in a timely fashion. That’s why it’s a good idea to put your earnings to work by setting some aside into a retirement plan.
Example #1: Greg and Sally started their small business four years ago. Last year the business finally generated enough revenue to cover expenses, which meant they no longer had to dip into their line of credit. Their three full-time employees stuck with them through the financial rollercoaster of the past few years, and now they are ready to fund the right retirement plan for them and their employees.
Option #1: SIMPLE (Savings Incentive Match Plan for Employees) IRA
As the name implies, it’s simple to administer and low in cost. Under this plan Greg, Sally and their employees can make contributions. In 2011 they can contribute up to $11,500 plus $2,500 if they are 50 or older. The owners have to cover all employees earning at least $5,000 annually and must either match the participating employees’ contributions or put in a fixed percentage of all eligible employees’ pay.
Option #2: 401(k) Plan
This is probably the most popular retirement plan. Employees can defer a portion of their salary into a 401(k) Plan. The employer cannot discriminate against the lower paid employees, so to be on the safe side, Greg and Sally can make either matching contributions or a 3% contribution to all participating employees. Greg and Sally, as well as their employees, can put in up to $16,500 plus $5,500 if age 50 and over.
Also, employees can borrow against their 401(k) in the event of a financial hardship, subject to certain rules and limitations.
This plan can be costly for small employers with a few employees.
So, if Greg and Sally want to maximize their contributions, clearly a 401K plan would allow them to put in the most out of the two. If they are looking for a plan with the least cost and administrative burden, the SIMPLE IRA is the way to go.
Example #2: John is an attorney whose part-time paralegal Angie who has been with him the past five years. John is 38 years old and wants to start an inexpensive and simple- to-set-up retirement plan.
A SEP (Simplified Employee Pension) IRA would allow him to do that. It is easy to set up and administer, and has a very low cost. You don’t have to file any annual reports with the IRS. The employer solely funds this plan. In 2011 John can put up to 25 percent of his and Angie’s total compensation or $49,000, whichever is less. If John has a bad year, he can modify or skip the contribution.
Other options, such as defined pension plans that are becoming as obsolete as your 70s Nehru jacket, are simply beyond the scope of this column.
Finally, if you don’t have enough cash flow to fully fund any of the plans outlined above, set up a Roth IRA for yourself. You can make contributions if your adjusted gross income doesn’t exceed:
- $156K if you file jointly
- $99K if you file as single
Your Roth IRA contributions are not tax deductible, but withdrawals made after you retire will be tax-free. In 2011 if you are less than 50 years old, you can sock away up to $5,000. That amount increases to $6,000 if you are 50 or older.
Mystified by money and want to improve your financial effectiveness? Denisa Tova CFP®, CDFA, MBA is a Colorado Springs-based Certified Financial Planner and a Certified Divorce Financial Analyst. Contact her at DenisaTova.com or email denisa.tova@gazette.com.
