The 2001 tax law enhanced Safe Harbor 401(k)s, retirement plans that allow one-person businesses to grow their shops. Mike Rose, director of retirement planning at Lord Abbett, says Safe Harbor 401(k)s are more attractive than ever for businesses with 10 or fewer employees.
The Safe Harbor 401(k) is a pre-tax payroll investment plan allowing business owners to stash away up to $11,000 in 2002, for instance, and receive either a 3% employer contribution or matching contribution of 4% to 6% of pay. Owners are also able to make profit-sharing contributions of up to 25% of compensation. “Business owners can now add a profit-sharing plan, which can boost the total contribution to 25% of pay or $40,000,” Rose says.
For those one-person businesses that are looking to grow, the Safe Harbor 401(k) allows them to move beyond one-person retirement plans. And, Rose says, the Safe Harbor 401(k)s offers more benefits than traditional small-business retirement plans. Entrepreneurs face the daunting challenge of choosing a simple IRA, a SEP IRA, or a profit-sharing, money purchase, or defined benefit plan, a decision that can “get complicated,” he says. “What we noticed with the new safe harbor regulations is that whenever we compare a Safe Harbor 401(k) to a simple IRA, SEP IRA, a profit-sharing or money-purchase plan, the owner almost always gets a larger percentage of the contribution, which is the objective for them, and also they can usually reduce their funding costs or increase the contribution.” And compared to SEP IRAs, profit-sharing plans and money-purchase pension plans, business owners can almost always either decrease annual funding obligations or increase overall contributions.
And employers can use a matching contribution to satisfy “top-heavy” IRS rules, he says. “Top-heavy” rules, he explains, impose a contribution limit on owners of small businesses if they have more than 60% of the plan assets in their account. In working with entrepreneurs, he says, Lord Abbett “always had little bit of a conflict because what owners of closely held companies typically like to see when they establish a plan is they like to get as much of the contribution as possible, but with the top-heavy requirement they always had to make significant minimum contributions. That would sometimes mean they couldn’t put as much money away, especially in the case of a 401(k) plan.”