Small Businesses Now Can Afford Big Benefits
It’s not often that legislators make a decision with no downside, but the U.S. Congress seems to have done just that in their enactment earlier this year of the Economic Growth & Tax Relief Reconciliation Act (EGTRRA).
Targeted aggressively at pension reform, EGTRRA has given those of us who provide retirement planning services to small business owners a golden opportunity: the chance to offer our clients a simpler, less expensive and highly tax-advantaged retirement plan for themselves and their employees (see sidebar).
Big changes, big impact. What exactly do all of these changes mean to the owner of a small business? Plenty! Let’s look at two examples.
Consider the “baby boom” era owner of a small business earning $200,000 a year who hasn’t established a profit-sharing plan. He might have funded his own SIMPLE or SEP plan, but that has allowed him just a $6,000 annual deferral and a 3% match, so his annual savings have reached a maximum of $12,000–hardly enough to assure retirement with a comparable standard of living.
By establishing a profit sharing plan under the new comparability guidelines, his annual contribution to that plan could total up to $34,000 in 2002. And, if his wife joins the staff, even at a modest $15,000 annual salary, she can defer up to $11,000 of her income in a 401(k), and make a $1,000 catch-up contribution in 2002 if she is age 50 or older.
In 2002 alone, they’ll be able to set aside $47,000 for retirement–$35,000 (includes $1,000 catch-up contribution) for the owner and $12,000 for his wife. As the table in figure 2 illustrates, the owner establishes a new comparability plan with a safe harbor 401(k) plan which exempts the 401(k) plan from discrimination testing.
And, as figure 2 illustrates, the benefits reach even the lowest-paid employees in the company, giving our small business owner a compelling recruiting and retention advantage (see figure 2).
What about the owners of another small business, who already have established a money purchase plan for themselves and their employees? Why is EGTRRA important to them?
The answer is simple. EGTRRA’s passage means that money purchase plans are prime candidates for conversion to a profit-sharing plan. (The only exclusions are union plans in which the collective bargaining agreement mandates contributions to a pension rather than a profit-sharing plan; and Davis Bacon plans, whose prevailing wage contracts require part of employees’ hourly pay to be placed in a money purchase plan.) Why? Because money purchase plans will no longer offer a higher deduction limit than profit-sharing plans or 401(k) plans, but will still require a predetermined annual contribution.
So, for that client, conversion to a profit-sharing plan should be an easy sell. The table in figure 3 shows how both the owners of the company and their employees will benefit (see figure 3).