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In Focus #70: June 9, 2009


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Retirement Plans That Care For Your Needs And Shelter You From The Tax Man


t never is too early to explore retirement plan options. Why? There are several reasons. Americans are living longer and getting healthier, inflation (like taxes) appears to be a permanent fact of life, and it is doubtful that we will be able to rely upon the government (Social Security and Medicare, for example) as the primary source of financial support.

When estimating retirement expenses, realize that certain costs will increase and others will decrease. For example, you may see a decrease in taxes, mortgage payments, education costs, loan repayments and life insurance. On the other hand, your may see an increase in health care costs, recreation and entertainment costs and the general cost of living expenses (for such items as food, clothes and fuel).

The primary sources of retirement income usually are: personal savings, social security, other retirement income (from a part-time job, rent from income properties or pension), IRAs, SEP-IRAs, Keoghs, and employer sponsored retirement plans. There are calculations available to project this retirement income. And there are calculations available to determine the amount of money that you should be saving now to ensure that you can meet your projected retirement income.


Basic Options

IRAs are a familiar kind of retirement account. These individual retirement accounts provide maximum flexibility, a current year tax deduction for your IRA contribution (depending upon your income level and participation in other plans), and tax deferred growth of your IRA investments.

Self-employed individuals and small companies can take advantage of the SEP-IRA. Contributions can be greater than the regular IRA. Employers must contribute the same percentage of income to employees (with sufficient work) as they contribute to themselves. An employer can contribute still more by adopting the SARSEP-IRA, in which the employer elects to include a salary-deferral feature (and have 25 or fewer employees). Overall, the SEP options allow for tax deductions, tax-deferred growth, full vesting and the ability to continue to contribute to a regular IRA.

401(k) plans offer another excellent opportunity to save for retirement in a tax-sheltered fashion. Contributions (pre-tax to the employee) and matching contributions (deductible to the employer) can be made up to $9,500 per year, with tax deferred growth. Like the IRA options, there are penalties for early withdrawals, unless you qualify for a special exemption, such as a disability.


Keogh Plans

Even greater rewards are possible with Keogh plans. Although they work like IRA's, higher tax deductible contributions are permitted. The three most popular types of Keogh plans are profit sharing plans, money purchase plans and combination plans. Here, you can contribute as much as $30,000 annually, and the plans can be structured so as to allow varying contributions year to year.

Importantly, Keogh plans must be adopted before the end of the business tax year (usually December 31st). Contributions may be made up to the time for filing the employer's federal income tax return, including extensions.

A main advantage to employers is that IRS regulations create opportunities for them to shift substantial portions of their contributions to themselves and to any key employees whom they choose. In fact, these plans can create annual contributions as high as 25% of salary ($30,000 maximum) for owners/key employees while, at the same time, contributing as little as 3% for other employees (which is the top heavy minimum).

Many investment advisors and third party administrators do not offer this substantial benefit to their clients. This is odd, given that the IRS regulations allowing this benefit (what we call "cross testing", "comparability" or "age-weighted" testing) have existed for several years. Indeed, these testing methods were developed because older individuals have less time to build a nest egg for retirement. Simply to stay even with younger employees, it makes sense for older individuals to receive a higher percentage of pay allocation than the younger plan participants.

As an example, consider the following true scenario. A company with three owners and eight employees currently enjoys a retirement plan. Unfortunately, the three owners each contribute only 14.3% of pay, which is the same percentage of pay as their eight employees. In sum, the three owners contribute 42%; they contribute the remaining 58% to their employees.

By comparison, cross-testing allows us to recommend increasing the owners' percentage of pay. Thus, instead of 42% of total contributions, the owners now can contribute 25% each for a total of 75%. And instead of contributing 58% to their employees, the owners now can contribute 25%.



Sponsored by James J. Eccleston. This Web site contains material of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
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