Many business owners believe they can’t afford to set up a group retirement plan for their company. I always respond, “You can’t take a loan for retirement. Therefore, you really can’t afford NOT to save for your future, unless you want to work until you die.”
Tax Benefits of Saving For Retirement Now
What some employers may not understand is that the administrative costs associated with setting up and maintaining a group 401k plan are tax-deductible expenses. In addition, the more money they contribute to their individual retirement plan accounts, the less money they will pay Uncle Sam. This is great news unless the IRS is your favorite charity. Personally, I like to keep more of my hard-earned money.
Safe Harbor 401k Plans
I advise most small business owners to set up a Safe Harbor 401k Plan. This type of retirement plan requires the employer to contribute 3% to each employee’s personal 401k account, including the owner of the company. Each employee may also contribute up to $18,000 to his or her individual 401k account. All contributions are tax-deductible.
Typically, a Safe Harbor 401k Plan allows the employer to contribute substantially more money pre-tax to a retirement plan. This type of retirement plan is a great fit for small business owners who are making a much higher salary that the staff. Examples would be a dentist’s office, a physician’s office, or any other professional services firm. For example, if the employer makes a salary of $200,000 and the next highest paid employee makes $40,000, 3% of the owner’s salary will allow him or her to put away substantially more money pre-tax.
Furthermore, the contributions to each employee’s account are restricted to a vesting schedule and eligibility requirements. Most employers require an employee to work full-time, be over age 21, and be employed for at least 1 year, or more, before being eligible for a 3% safe harbor contribution from the employer. In addition, the funds vest over several years. Most vesting schedules are for five years but this varies by each plan. If the employee resigns from the company, any funds in their retirement plan that are not vested automatically go into a forfeiture account. The employer can use the forfeiture funds as he or she wishes to manage the maintenance costs of the 401k plan.
The earlier you start saving for retirement, the longer you have to take advantage of compounded growth. In other words, time is on your side for growing your assets in your portfolio. Another key benefit of 401k contributions is that they are made systematically over the entire year each time payroll is processed. As a result, the investments in the entire 401k plan, for the employer and the employee, get the benefit of Dollar Cost Averaging.
Dollar Cost Averaging
Dollar Cost Averaging is a strategy used to reduce the volatility in an investor’s portfolio. The strategy allows an investor to buy a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. The investor purchases more shares when prices are low and fewer shares when prices are high.
Another little known fact is small business owners can employ their spouse as a highly compensated employee. Then both individuals can fully contribute to a 401k account for the same company. The current maximum allowable contribution to a retirement plan is $18,000 for 2017. If you are Age 50 or older, you may also contribute an additional $6,000 as a catch-up provision.
Avoid Early Withdrawal Penalties
Please remember that funds grow tax-deferred in a 401k plan. Ideally, you will not take a withdrawal from a retirement plan until after Age 59 ½ to avoid a 10% early withdrawal penalty. This helps deter people from dipping into their retirement accounts to buy something they really don’t need. When it’s time to start taking withdrawals from a retirement plan, the investor should be retired and in a lower-income tax bracket.
There is good news on the horizon. Investors will be allowed to contribute an extra $500 to a 401(k) plan next year. The government will raise the contribution limit to $18,500 in 2018. The catch-up contribution limits for individuals age 50 and older will remain unchanged at $6,000 per year.
Seek Wise Counsel
Once a person is ready to retire, they will need an expert to help them transition from the accumulation phase to the annuitization phase. The annuitization phase of life begins when an individual stops working and their money starts working for them. They will need to create an income stream, or annuity, that they cannot outlive. Otherwise, they will have to go back to work in some capacity. In this stage of life, I always advise my clients and my readers to seek wise counsel from a trusted Financial Advisor who specializes in working with retirees. Be proactive today with your retirement planning so you can enjoy the fruits of your labor tomorrow.
For more information, I hope you will check back in with me regularly and often. I will be providing advice, tips, and encouragement for you to learn how to live your best life possible from a financial standpoint.
If you want to dig deeper and have a much better understanding of how to achieve true financial freedom, then I encourage you to purchase a copy of my newly released book: