This post is based on a consultation I had today that echos a very common business planning theme: A successful small business owner wishes to begin a retirement savings plan to make the most efficient use of the business’ profits.
The goals are simple:
- Maximize the owner’s account contribution,
- Maximize tax savings (avoid current income taxation), and
- Minimize the other costs of the plan (including administrative fees and mandatory employer contributions on behalf of employees).
There are three primary strategies used in this situation and the effectiveness of each depends on the individual business and its situation. Each has advantages and disadvantages and each eventually triggers a taxable event on previously untaxed earnings.
A. Private Pension Plan – this works best with few employees and a large gap between the owner and employee wages. It also helps it there is a large gap in age between owner and employee. The ideal situation, for example, would be an owner, age 62, making $300,000 using two part time office staffers, age 26, making $20,000 each.
B. Safe Harbor 401(k) – by having the employer commit to minimum contributions for all employees, the owner can contribute a dis-proportionally larger amount to her own account.
C. Non-qualified deferred compensation – the business sets aside funds into an account, often a cash value life insurance policy, that is owned by the business so that it is not taxed as current year compensation to the employee. The account grows tax-deferred and then the money is taken out years later as a tax-free loan to the owner.
Often the best solution turns out to be a combination of two or all three of these options. The best way to compare the possibilities and limitations of each option is to order a proposal based on the specific payroll census data of your firm. I offer this retirement plan comparison service under the umbrella of concierge advisory services so please request a conversation to allow us to explore the topic in more detail.