A Perfect Match

Choosing the right retirement plan for you and your business

Six years ago, Richard Harkness' business was going through a rough patch. His Sacramento company, Advanced Drivers Education Products & Training (ADEPT), offers special driving courses to teenagers to reduce their odds of car crashes. The business had a few exclusive contracts, but those weren't generating the revenue needed to stay afloat.

Harkness made his nine employees a promise: If they stuck with ADEPT through the bad times, he'd reward them in better days with a solid retirement plan. Harkness has kept his word. First, he got ADEPT back on track. Harkness ended the exclusives and started working with the American Automobile Assn. and others who sell driving classes, helping push revenues to $1.4 million in 2004.

In April, Harkness set up a retirement program known as a Safe Harbor 401(k) New Comparability Profit Sharing Plan. ADEPT matches the annual contributions of its employees, up to 4% of their compensation. The plan cost ADEPT about $900 to establish, and Harkness figures the match will run about $10,000 each year.

For Harkness, that's money well spent. The 55-year-old intends to contribute the $46,000 maximum to his own account this year, cutting his personal income taxes by about $16,000. "A lot of time has gone by during which I couldn't save," says Harkness. "It's been 10 years since I started the company, and I need to catch up."

Harkness is hardly the only entrepreneur to put retirement planning on the back burner while struggling to build a company. A March, 2004, survey by the Labor Dept. found that only 40% of companies with fewer than 100 employees had a retirement plan in place.

There has never been a better time to start saving. Changes in tax laws during the past few years have upped contribution limits and made setting up plans much simpler. In addition, recent IRS rulings have made it easier for owners to get the most out of the plans.

The tax advantages are as attractive as ever. Corporate and individual contributions to retirement plans can be deducted from taxable income, growing tax-free until the money is withdrawn at retirement. "When you're looking for ways to save on taxes, it's a no-brainer," says Phillip Cook, certified financial planner and owner of Cook & Associates in Torrance, Calif.

Administrative costs are reasonable, too. Fees range from $50 or less to establish an Individual Retirement Account to about $500 to $1,500 for a 401(k) and up to $2,000 for a defined-benefit plan. Small businesses can get a tax credit for half of these fees for the first three years of a plan's existence, to a maximum of $500 a year. A financial adviser will generally charge about 1% of assets to manage a plan, while mutual-fund fees typically range from 1% to 1.85%.

Small business owners can choose from five main types of plans: SEP-IRAs, SIMPLE IRAs, 401(k)s, profit-sharing plans, and defined-benefit plans. Two noteworthy variations are Safe Harbor 401(k)s and combined 401(k)s and profit-sharing plans.

Qualified plans -- those that aren't IRAs -- generally must be approved by the IRS and require annual reporting to the IRS and Labor Dept. Plan administrators also must conduct annual anti-discrimination tests on those plans to ensure that they don't unfairly favor employees earning $90,000 a year or more. On the flip side, these plans have higher contribution limits and are protected against creditors and liability claims. "If the employer can afford to do a qualified plan, we recommend it because of the [legal] protections," says Diane M. Pearson, CFP at Legend Financial Advisors in Pittsburgh.

Your plan choices increase as the size of your company -- and your budget -- grows. "We always ask our clients, `how much money do you want to put away: $25,000, $50,000, or $100,000?"' says Michael E. Kitces, director of financial planning at wealth-management firm Pinnacle Advisory Group in Columbia, Md. "That number alone will do a lot to steer you toward a plan." It will also help to do a quick employee census of ages, compensation, job functions or titles, and hire dates to see how many of your employees are eligible and which plan is best for your company.

With most plans, you'll max out at the federal limit of $44,000 a year (slightly higher for older workers). Others, such as defined-benefit plans, will let you sock away substantially more.

Be careful not to overreach. If you choose a plan that requires you to match employee contributions, make sure you'll be able to do so. You can always change plans as your company grows. "I have started clients with just a 401(k) and migrated them to a richer plan as they grew," says Afolabi C. Odejimi, CFP and a principal at Odyssey Group, a financial-planning and business advisory services firm in Phoenix. "You really need to assess your capabilities. If you can't take advantage of the maximums, what good is the plan?"


In January, Debbie Thompson, president of Strategy Solutions, a market research and strategic planning firm in Erie, Pa., found the ideal candidate to become business manager of her three-employee, $350,000 company. But the prospect wouldn't sign on unless Strategy Solutions had a retirement plan. "I needed her and I wanted her, but she wouldn't come to work here without the benefit," says Thompson.

Two types of IRAs -- Simplified Employee Pensions (SEPs) and the Savings Incentive Match Plan for Employees (SIMPLE) -- are designed for smaller companies like Thompson's. All business owners and sole proprietors are eligible for SEP-IRAs, the only variety of plan that can be set up after the end of the calendar year. Only employers make contributions to SEPs, up to 25% of income (up to $44,000) in 2006. Those with employees generally must make the same percentage contributions to their accounts.

That can get expensive once you have more than a handful of employees. In that case, a SIMPLE IRA may be a better choice. For 2006, contributions to SIMPLE IRAs are capped at $10,000, or $12,500 for employees over 50. Employers must either match the amount each employee contributes up to 3% of their annual compensation or kick in 2% of compensation for all employees eligible for the plan, regardless of whether they participate.

Thompson went with a SIMPLE IRA and hired her new manager. The plan cost a mere $10 to set up. Thompson expects to spend about $3,500 -- "not a lot of money," she says -- matching employees' contributions this year. And the 45-year-old Thompson will stash away $4,000 herself. "It's been a few years since I had a regular retirement plan," she says. "But with a salary reduction plan, it's easy."


A 401(k) makes it easier for owners to save more. The plans allow both employer and employee contributions, although employers aren't required to kick in anything. All participants can squirrel away up to $15,000 in 2006, or $20,000 if they're 50 or older.

The downside? More paperwork. The plan administrator, generally a fund company or third-party administrator, has to report on the plan and run yearly anti-discrimination tests. If not enough lower-paid employees contribute to their accounts, higher-salary employees may not be able to save the maximum. If they try, they may see their contributions returned -- as taxable income.

John Brothers, president of Custom BioGenic Systems in Shelby Township, Mich., a maker of cryogenic-freezing equipment for biological samples, had received one too many "refunds" of his contributions. So in 2002 the 43-year-old spent $750 creating a so-called Safe Harbor 401(k) for the 48 employees of his $6 million company. By kicking in an annual match of 3% for all of his employees, Brothers exempts his company from the discrimination testing required of traditional 401(k) plans. (Another option would have been to offer a 4% match only to participating employees.)

This way, Brothers not only avoids surprises but also has been able to save more for himself. Previously he couldn't make the maximum contribution to his own account without failing the tests the standard 401(k) requires. "It's a very good plan," says Brothers. "I've been able to put more in, while giving employees a reason to get involved and save for their futures."


Owners of businesses generating good revenues can save even more with profit-sharing plans. These tie contributions to company profits rather than compensation. In 2004 the IRS simplified the documentation required for cross-testing these plans, making it easier to skew benefits toward business owners or a particular group of employees.

Here's how they work: A company distributes profits into employee accounts based on a formula created when the plan is set up. Traditionally, most profit-sharing plans allocated benefits to all employees based on a percentage of compensation. But a version of the plans called new comparability, or cross-tested plans, allows owners to divide employees into two or more groups based on factors such as age, compensation, or job title. For example, a plan could group employees into owners and all other employees, or owners, salespeople, and everyone else. These formulas allow owners to minimize the costs of the plan while maximizing benefits to a target group. One drawback: The cross-testing can drive up annual costs to about $1,500 to $2,500, compared with less than $1,000 for traditional plans.

Switching to a profit-sharing plan has dramatically boosted Manny Sousa's savings. In 1996 the owner of Sousa Court Reporters in Hermosa Beach, Calif., opened a SEP-IRA for his three employees. As he started hiring more staff, most in their 20s and 30s, his financial adviser suggested the $2.8 million company try a profit-sharing plan that would let older employees save more. In 1999, Sousa spent $800 to set it up, and administrative fees have run about $600 a year. "The plan has really been wonderful. I can put away more money and still benefit my employees," says Sousa, 55. He has since contributed a total of about $10,000 a year to his nine employees' accounts and has put away $38,000 a year for himself.


If you need to save a lot in a short time, your best bet may be a defined-benefit plan. They work well for businesses in which owners or a few employees make a good deal more than other employees. They can also be smart for sole proprietors.

Defined-benefit plans provide a fixed stream of income after retirement. Only employers contribute to these plans. There are no contribution limits. But contributions can't yield a retirement benefit that's more than either $175,000 a year or the average compensation an employee earned during her three highest-earning years. You'll need an actuary to calculate how much money you can put into the plan each year and a financial adviser to set one up.

A defined-benefit plan has been a boon for Josef Blass, the 60-year-old owner of Kosciuszko Leasing in Pittsboro, N.C., and his wife, Eva. She's the managing director of the $3 million company, which advises companies expanding into Eastern Europe. Since 2001, when they started a form of defined-benefit plan called a cash-balance plan, they've saved $150,000 every year. The Blasses contribute a tax-deductible total of $55,000 annually to their three employees' accounts. The accounts are invested to earn a target interest rate, typically around 5%. If they miss that mark in a given year, the company must make up the difference.

Blass estimates they've knocked about $120,000 off of their personal taxes since starting the plan. "There are few things worth promoting as much as a retirement plan," says Blass. "There's nothing else like it for small business owners." With tax breaks like the Blasses are getting, there's no reason to put off retirement planning any longer.

By Virginia Munger Kahn

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