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).
By converting from a money purchase to a profit-sharing plan, employees of Johnson Wiring will now be able to make 401(k) salary deferrals, and the new comparability plan design will allow its owners to save more. Addition of the safe harbor contribution means that the plan will not be subject to the ADP test and can be used to satisfy top-heavy minimum contribution requirements, if necessary.
Even more noteworthy: owners now save $80,000 ($58,000 employer contribution plus $22,000 401(k) employee savings), while workers save $12,800 ($6,800 employer contribution plus $6,000 401(k) employee savings).
Set-up, administration costs reduced. If the wealth-building opportunities aren’t enough to convince your small business clients to establish or update their retirement plan, the cost breaks and tax credits offered in EGTRRA could seal the deal.
As of 2002, EGTRRA increases the deduction limit for employer contributions to profit-sharing plans from 15% to 25% of total compensation paid to eligible employees, for taxable years beginning after Dec. 31, 2001–giving employers a bigger tax deduction for their contributions.
In addition, before EGTRRA, employers had to subtract 401(k) employee deferrals from their companys eligible payroll figure to arrive at the 15% deduction limit. Under EGTRRA, employee deferrals are not required to be subtracted from compensation–giving employers an increased deductible amount.
For companies with 100 or fewer employees who each earned at least $5,000 in the prior year, there’s a tax credit of 50% of the first $1,000 in administration and retirement education expenses for each of the first three years of the new plan. This credit is available for new plans in which at least one non-highly compensated employee participates, for taxable years beginning after Dec. 31, 2001.
Employers may also offer retirement planning services to their employees on a non-taxable basis, if they offer those services on substantially the same terms to a reasonable classification of employees.
Further, the IRS will waive the user fee for determination letter applications filed after Dec. 31, 2001 concerning the qualified status of a new plan during the plan’s first five years, for small businesses (100 employees or less) that set up new plans in which at least one non-highly compensated employee participates.
Opportunity abounds. Clearly, EGTRRA offers agents and producers a golden opportunity to serve small business clients by helping them recognize the value of establishing or updating their corporate retirement plan. Although its complexity requires a thorough understanding of ERISA and IRS regulations, its benefits are obvious.
By selecting a retirement plan provider whose staff can customize its plans to meet the specific needs and objectives of each client, you will help ensure not only the financial future of that client and its employees, but help ensure your own success in the process.
Peter A. Welsh, a regional vice president for Los Angeles-based Transamerica Retirement Services, manages the company’s central region, in Chicago, Ill.. He can be reached via e-mail at [email protected]
Reproduced from National Underwriter Life & Health/Financial Services Edition, October 15, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.