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Expanded Retirement Plan Contribution Limits Create New Opportunities For Business Owners

Starting in 2002, retirement plans such as 401(k)s, qualified profit-sharing, money purchase and defined benefit pension plans as well as SIMPLE IRAs and SEPs offer expanded contribution limits for the business owner.  These higher contribution limits, due to tax savings, often offset and/or exceed contributions made on behalf of employees.

401(k) Plans:

401(k)s give participants the power to defer part of their pay on a deductible basis.  This plan can be used in conjunction with a qualified profit-sharing plan or as part of an employee stock ownership plan called a KSOP.  Participants can defer up to $11,000 of their pay.  For those employees over age 50, an additional $1,000 can be contributed as a catch-up contribution.  Additional employer contributions on behalf of employees can be up to a total of $40,000.  The investments that can be used with these plans include: stocks, bonds, government securities, mutual funds, annuity contracts, insurance contracts, bank commingled trust funds, bond deposits, partnerships, real estate, mortgages, options, futures, and commodities.

For-profit businesses such as corporations, sole proprietorships, partnerships, limited liability companies, limited liability partnerships, and not-for-profit organizations, such as hospitals, trade associations, schools, and charities can offer 401(k)s.

The advantage of a 401(k) for an employer is the minimal costs that would be incurred if an employer does not make contributions on behalf of employees.  For the employee, it is the freedom to choose how much you will defer.  The disadvantage is that some employees might choose to not participate, and therefore, they will not build up a retirement savings.  Many employers choose to contribute approximately 3.0% of salary to an employees account to keep the plan in compliance.

Qualified Profit-Sharing Plans:

This is a defined contribution retirement plan.  Contributions are made by the employer and may be based on current or accumulated earnings and profits.  The contribution amount is flexible and ranges between 0% to 25%.  To determine how much is to be given, the employer must create a formula and explain it in the plan documents.  This formula can be geared to favor certain age groups, employment tenures, pay levels, or divisions as long as it passes non-discrimination tests.

The benefit of profit-sharing plans to the employer is that it enables them to make contributions, but they are not locked into a fixed commitment regardless of bottom-line performance.

Individual Retirement Arrangements or IRAs:

IRAs let individuals save money for retirement and deduct that amount from taxable income.  Beginning in 2002, the deductible limit is $3,000, or $6,000 in the case that the participant has a spouse.  For those over age 50, they can make an additional catch-up contribution of $500. 

IRAs are set up as trusts or custodial accounts.  In custodial accounts, a wide range of funding methods can be used; stocks, bonds, mutual funds, etc.  Life insurance cannot be used to fund IRAs, and IRAs cannot be mixed with qualified trust assets.  Distribution flexibility make IRAs appealing.  Payments can be made in a single sum, regular installments, or sporadic distributuions.

Simplified Employee Pension (SEP) Plans:

SEP plans were created for small employers to encourage them to set up retirement plans for their employees.  Under this plan, contributions of up to 25% of pay are made to an IRA account for the employee.

SEP plans make the whole process easy and less costly on the administrative end for employers.  They simply make a contribution to an IRA account.  The amount, however, must be the same percentage contribution for all employees regardless of tenure or position.  This may mean that contribution costs could be higher than desirable.

Employees eligible for SEP plans must be at least 21 years old, have worked for the company during any three of the last five years, and earned at least $450 in pay for the current year.  Companies sponsoring SEP plans can use all funding vehicles available with IRA accounts and must follow all restrictions as well.

Savings Incentive Match Plans for Employees (SIMPLE) IRA:

Under this plan, employees can defer part of their pay into an IRA account and the employer will match it.  Salary deferrals are limited to $7,000 per year.  Employees eligible for SIMPLE plans must have earned at least $5,000 in a two-year time period and are expected to earn at least $5,000 during the present year.  Employers provide a 100% match on deferrals up to 3% of compensation.  This match limit can be reduced if notice is given 60 days before the deferral election period.  Thirty days before year’s end, each participant must receive a statement showing the amount in the account and the account’s activity.

Companies with fewer than 100 employees and who are not offering other qualified plans can offer SIMPLE plans.  The employer benefit is that SIMPLE plans are easier to administrate than 401(k) plans.  However, due to decreased flexibility and the required match contribution, costs are more expensive for SIMPLEs than 401(k)s.

For further information, contact Louis P. Stanasolovich, CFP at (412) 635-9210 or

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