The question of IRA vs 401k leaps to mind when setting up a small business retirement plan. Do you know the differences between plans? What does the Internal Revenue Code allow and restrict? Why should you even care? Because if you sell fixed indexed annuities and want to capitalize on one of the hottest specialty markets going today (setting up retirement plans for small business owners with 1 to 9 employees), you’ll want to brush up on IRA vs 401k and other important considerations.
First, consider that a small business retirement plan, now more than ever, is the best way to defer large amounts of tax-deductible dollars. Thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), self-employed taxpayers now have unprecedented incentives to save for retirement. A business owner’s decision is quite literally whether to keep company profits… or send them off to Uncle Sam.
OWNER GETS MORE
It’s no secret the allure of a small business retirement plan is directly related to benefits available to the owner. The greater the owner’s share of the overall plan, the greater the interest. Before the new tax legislation, restrictions on owner’s benefits in small plan design often resulted in even fewer benefits for the employees. But the tools are now in place to ratchet up the owner’s benefits and still create a workable plan for the employees. So, should the plan be an IRA or a 401k? Let’s examine IRA vs 401k separately.
SIMPLIFIED EMPLOYEE PENSION
The simplest small business retirement plan for self-employed taxpayers and the easiest to set up and maintain is the Simplified Employee Pension (SEP). You may establish a SEP if you earn self-employment income, regardless of whether you have employees. A SEP is an Individual Retirement Account (IRA) and if maintained for more than one person becomes a group of IRAs.
All contributions to a SEP are tax deductible as a business expense. As an IRA the plan’s earnings are not taxed until they are withdrawn at retirement. As usual, withdrawals prior to age 59 ½ with this and other plans incur a 10% penalty. A SEP-IRA does not permit loans or salary deferral contributions. Also, the individual annual contribution limit for 2006 is the lesser of 25% of compensation or $44,000, and contributions may be reduced or skipped altogether in lean years.
Another handy tool in the EGTRRA toolbox is the Individual or Solo 401(k). This small business retirement plan is ideally suited for businesses in which the owner or owners (and their spouses if working at the business) are the only employees. The biggest reason for opening a one-person 401(k) is the higher contribution limits allowed, plus the fact that contributions are based on revenue generated by the business.
The maximum tax-deductible employer contribution is 25% of gross eligible payroll. For 2006 the maximum effective salary deferral contribution for employer plus employee is $44,000 plus a catch-up contribution of $5,000 for individuals age 50 and over. Loans are permitted subject to limits and rules, and paperwork may be just a filing of the streamlined IRS Form 5500-EZ when plan assets exceed $100,000.
NEVER A BETTER TIME
The new tax law creates a multitude of opportunities with more than 60 new provisions to strongly encourage the startup and funding of your small business retirement plan. Variations in plan design allow opportunities to suit independent contractors, sole-practitioner professionals, small retail owners—virtually every type of small business imaginable. Answer the question of IRA vs 401k and you’re on your way.
For small business owners in search of large tax breaks, it doesn’t get any better than this. There has never been a better time than right now to convert current taxes into assets, defer tax payments, and generate large amounts of retirement income. And for you as the fixed indexed annuity specialist, this market is virtually untapped.
Gary Le Mon