Fortune Small Business: Rich and Retired, Come up with a Plan Now Article
Rich and Retired
Don't count on your business. Come up with a plan now to fund your financial
By Abby Schultz
It was a typical response from a small business owner, says financial adviser
Bruce Fenton. He asked a client, an antiques dealer from Brimfield. Mass., if he
had socked away any money for retirement. The answer? The merchant turned. waved
a, hand around the shop, and declared, "This is my retirement plan But as Fenton
and others will tell you, only a fool bets his or her future on a business that
can become pass in the blink of an eye. "Nobody puts all their money into IBM or
Microsoft, says Fenton, president of Atlantic Financial in Wellesley, Mass. "You
prevent diversity and stability."
If you're muttering, "I'll get to it, I'll get to it, and you're not alone. Less
than half of all businesses with fewer than too employees have a retirement
plan, according to the latest Bureau of Labor Statistics data.
Fluctuating revenues, roller-coaster cash flow and a young and restless or
less educated employee base account for the procrastination, according to a poll
of small business owners taken earlier this year by the Employee Benefits
Research Institute, a nonprofit research group in Washington, D.C.
Unfortunately, those without a plan are often unaware of the many options
designed specifically for small employers. The two types of savings incentive
match plans for employees-both Simple IRAs and Simple 401(k) s were a mystery to
33% of those polled, even though Congress created the plans three years ago to
reduce the administrative burden and costs associated with such plans for firms
with fewer than two employees. "Most owners are so caught up in day-to-day
operations, they do nothing about retirement says Michael Furois, a financial
adviser in Chesterton, Ind. Others wait too long to begin. "A lot of
entrepreneurs think they're invincible; they think somehow, they'll pull
through, like they always do," adds Fenton. The truth is, you have to start
saving significant amounts of money now to replace your income when you retire.
A 45-yearold who puts away just $ 6, 000 a year for 20 years will have only
$385,000 at age 65, assuming the investments grow at an average annual rate of
11%. That's not a paltry sum, but it's probably not enough to replace your
current annual income for 20 years or more in retirement.
To maximize your savings, consult with a financial advisor, benefits consultant,
or CPA versed in investing and retirement planning. Ultimately your plan choice
will depend on your business size and cash flow, the age and income of your
employees, and the number of years you have until retirement. It will also
depend on how much you need to save in taxes. To help you get started, we've
profiled the most popular options for small business owners: the 401(K) plan,
the Simplified Employee Pension Plan (SEP-IRA), the paired Keogh and the Defined
Benefit Plan. We've also worked with Morningstar, the mutual funds research
firm; to develop model portfolios to help first time investors navigate the
morass of fund options.
401(k)/ Profit Sharing
The most popular type of retirement plan is just for big corporations. If you
expect your business to grow and you need to attract top professionals in
competitive fields, 401(k) s are essential recruitment tools. With the aid of an
experienced advisor, they can be designed to allow a business owner and his
employees to save up to $30,000 per year.
LEADING THE LEAGUE
You don't need to run a big corporation to offer a 401(k) plan.
list of the top providers of such products for businesses with 100 or fewer
How it works: An employer matches tax-deferred employee salary contributions up
to $10,500 annually, so participants can salt away almost triple that amount (or
25% of their salary, whichever is less) by combining the plan with profit.
Although the employer is not required to contribute, matching dollars encourage
participation, which is in your interest: The more employees contribute, the
more you can save.
That's because total contributions for the highest-paid
employees such as you-are limited by the participation rates of low-paid
You can avoid some of these constraints at the expense of a more
complex plan by adding a profit-sharing component.
Or opt for what is
called a safe harbor 401i(k), which lets you dispense with nondiscrimination
testing (making sure that higher-paid employees aren't allowed to contribute a
larger percentage than lower-paid employees) if you agree to match your current
annual income for 20 years or more in every employee's contribution at a certain
minimum level and immediately vest these contributions on behalf of your
Al Cini, 51, owner of Computer Methods Corp, a 30-employee computer-consulting
firm in NJ typically defers $10,000 of his salary to his 401(k) plan.
many business owners he has found that such plans can be constraining since they
are designed to benefit employees.
So he was able to be creative because
his plan had a profit sharing component.
In its simplest form, profit
sharing involves distributing a percentage of profits to the employees as a
percentage of pay.
The IRS allows profit sharing dollars to be allocated
in ways that benefit business owners.
One way is to calculate the %
distributed to each employee using what's called Social Security integration?
This allows you to contribute a higher percentage of profits to earn more than
the Social Security wage base of $76,200.
This strategy has helped Cini
Besides building a larger retirement nest egg, he saves
about $20,000 a year in corporate taxes for the $50,000 his firm contributes to
Where to set up a 401(k): a bank, a mutual fund company, or a third party
administrator such as a regional benefits consulting firm, which often uses the
plans of discount brokers.
Beware of hidden fees: some plans impose stiff
penalties as much as 5% of plan assets for breaking your commitment.
Retirement Portfolios Everyone needs to tailor s retirement portfolio based on
one's penchant for risk.
The following are model portfolios that suit the
needs for three types of investors; aggressive, balanced and conservative.
Each model contains mutual funds selected by Morningstar
(http://www.morningstar.com/) because they are the best-of-class , have sterling
performance records and are not too pricey.
Conservative (50% stocks, 40% bonds, 10% cash)
Fund Name Allocation % 3-Yr. Return Phone (800)
Vanguard Total Bond Mkt 40 5.63 662-7447
Vanguard 500 Index 35 16.74 662-7447
Vanguard Prime Money Mkt. 10 5.40 662-7447
Vanguard Small Cap Index 10 7.07 662-7447
TIAA-CREF Intl. Equity 5 14.77 223-1200
Balanced (75% Stocks, 25% Bonds)
Fund Name Allocation % 3 Yr. Return Phone (800)
Harbor Capital Appr. 25 25.45 422-1050
Loomis Sayles Bond 25 4.77 633-3330
Legg Mason Value 20 21.11 577-8589
TIAA-CREF Intl. Equity 15 14.77 223-1200
T. Row Price Small Cap 15 9.84 638-5660
Aggressive (100% Stocks)
Fund Name Allocation% 3 Yr. Return Phone (800)
Janus Mercury 35 44.25 525-8983
Selected American 30 15.69 243-1575
Artisan Intl. 15 29.07 344-1770
MAS Mid Cap Growth 10 38.88 354-8185
Third Avenue Value 10 10.35 443-1021
Simplified Employee Pension plans are great for sole Proprietors and owners of
small companies, since they are nearly headache-free and allow a tremendous
amount of savings to be tax-deferred yearly.
The business owner
establishes an individual retirement account for each employee and funds the
account up to 15% of each employee's salary, to a maximum of $24,000.
Advantages: For business owners there are no income restrictions to reap the tax
benefits as with a traditional IRA.
Administrative tasks and costs are
minimal; annual filings to the IRS aren't necessary.
How it Works: Every employee gets the same contribution, which can vary year to
Having a bad year?
Contribute little or nothing to the plan.
Each IRA account can be held wherever the employee chooses, and employees decide
how to invest their own funds.
Caveat: It's not the best choice if you
have any part-time employees you don't want to include, because the definition
of eligible employees is so broad that you may wind up making contributions for
all your workers whether you want to or not.
Michael Gillis, 43, and David Bikofsky, 44, began a law partnership specializing
in business litigation in 1988.
Three years later they chose a SEPIRA
because it's simple to administer.
There axe no limits on how many
participants can be in a SEP, but they generally work best for businesses like
Gillis and Bikofsky's six-person firm, in part because funding the plan to
maximum could cost a larger firm too much.
Under SEP-IRA rules, only the
employer funds the plan.
Gillis and Bikofsky have been able to contribute close to 15% annually and never
less than 10%, Gillis says.
Where to set up a SEP-IRA: Fill out IRS Form 5305-SEP (http://www.irs.gov/) With
a certified financial planner, or see a brokerage, mutual fund company, or
financial services firm, which may charge minimal annual administrative fees.
T. Rowe Price charges $10 for each SEP-IRA mutual fund account but waives the
fee when assets in the fund exceed $5,000.
This individual retirement account allows a small business to establish a
retirement program without meeting stringent reporting and nondiscrimination
Its great for employers who can't t afford to fund the maximum for everyone in
As with the SEP-IRA, there is no income threshold plan on a
How it works: The maximum y can save in a Simple IRA is $12, includes a $6,ooo
maximum employee contribution.
The plans work well for, cash-strapped
companies because matching rules are flexible: You can match participating
employee contributions dollar for dollar, up to 3% of salary or as low as 1% in
any two of five consecutive years.
Or you can contribute 2% of salary a
year to all workers whether or not they are in the plan.
Sue Miller Long, 41, has owned a real estate appraisal firm in Phoenix for 16 <I
Last September, Long closed her
three-year-old SEP-IRA because she could not afford to fund it to the max for
her whole firm.
Instead, she created a Simple IRA for her employees, who
had requested a retirement plan.
She agreed to match I % of their
contributions for the first two years: shell raise that to 3% in 2001.
Because her business is cyclical, Long likes the flexibility of beginning with a
Where to set up a Simple IRA: Complete IRS Form 5304-Simple or 5305-Simple, and
get advice at a financial service firm-a mutual fund company, a brokerage or a
bank that offers investment services-or through a certified financial planner
Paired Keoghs are qualified retirement plans for the self-employed, where the
owner is treated as an employee for tax purposes.
How it works: 'the self-employed typically, establish Keoghs as a profit-sharing
plan or a money-purchase plan (otherwise known m a defined benefit pl@), but for
the maximum in savings they combine the two in to one. This paired strategy
allows you to contribute 25% of your annual compensation, up to $30,000.
When ML Systems (a subsidiary of Alcoa) closed 1994, area manager Gerald Helbig
started his business as a lighting contractor, opening Enercon Sturbridge, Mass.
He was 36 and married, with two children ages 9 and 12. At Alcoa, and at a
previous job with GTE, Helbig participated in 401(k) plans.
Now on his
own, he wanted to continue growing his savings while minimizing his tax bill,
putting as much into some type of tax-deferred e a paired Keogh to cut his tax
bill maximum allowed by law.
Enercon is an S corporation- company that can be solely operated or have fewer
shareholders that are taxed as a partnership--so all of Helbig's profits flow to
him as income for tax purposes.
Each year he contributes 10% of profits to
his money-purchase plan; he then funds his profit-sharing plan up to another 15%
of his annual salary, keeping his total contribution under the maximum 5% of his
So far the 42-year-old Helbig, who runs his company alone, has
earned at the maximum level each year. He has saved $162,000; his hope is to
retire comfortably at age 60 with $1 million, with help from another retirement
accounts from previous employers
Where to set up a Paired Keogh: through a mutual financial-services firm.
Helbig determines his contribution level and writes two checks: one to his money
purchase account and a second to his profit-sharing account.
consults with Atlantic Financial to determine where to invest, but he doesnt
choose the actual investments.
DEFINED BENEFIT PENSION PLAN
This stodgy stalwart can save your hide if you're in your mid40s or older and
haven't saved much of anything yet.
How it works: Instead of a fixed contribution as in a 4o1(k) plan, your
contributions to a defined benefit plan can vary every year so you can make sure
to hit the target benefit.
According to the law, that annual number must
be capped at 100% of salary or $135,000 whichever is lower.
A defined benefit plan provides tax savings, but if you fund your own plan an
toward a goal of receiving 100% of your pay at retirement you must do the same
for all employees; the IRS requires that all employees be treated equally. (If
employees are mostly younger, lower-paid workers, these restrictions shouldn't
be onerous.) You'll need a financial adviser to help you establish a plan, as
well as the ongoing services of an actuary, services that add to costs.
The actuary determines how much you contribute each year by following complex
formulas that take into account your age, number of years to retirement and any
future benefit you want to receive, and the assumed rate of return on the plan.
Mike Schlegel, 46, owns a sales and marketing business in Show Low, Ariz., and
has been in business since 1973.
Three years ago, the business began to
He had established a Simple IRA to begin saving for
retirement but converted to a defined benefit plan a year ago in hopes of
meeting his goal of retiring by age 55.
Schlegel paid $1,000 to set up the plan.
He will continue to pay the
same amount annually to administer it.
Because he saved little for
retirement until recently, he is catching up with annual pretax contributions of
These are saving him $15,500 a year on personal federal
Better yet, he doesnt have to match such large contributions
for his two silent partners, since they are not part of the plan.
Where to set up a defined benefit plan: You need a financial-services firm, a
certified financial planner or an employee-benefits adviser.