Small Business Owners

Establishing a retirement plan can provide significant benefits for small business owners and their employees. Current law allows for substantial, tax-advantaged funding of retirement benefits for organizations of all sizes and forms, including single-owner entities. Contributions to a qualified plan are tax-deductible for the organization in the year made. At the participant level, taxes on all contributions and plan earnings are deferred until benefits are received in retirement. The cumulative, compounded effect of this tax deferral can be substantial.

Retirement plans can be divided into two types:

Defined Contribution Plans

As the name implies, these plans target contributions. Deductible contributions are allowed up to $49,000 per participant for 2008 ($54,500 for those aged 50 and over). The most popular and familiar type of plan in this class is the profit sharing/401(k) plan.

Defined Benefit Plans

Again, the name here is telling. These plans target the level of retirement benefits. Annual benefits of up to $195,000 (2009) per participant can be funded under this type of plan. There is no stated limit on the amount of deductible contributions.

Defined contribution plans are an excellent option for many companies. The structure is straightforward, the benefits are easily explained, and the plan offers maximum funding flexibility to the company. Unfortunately, many business owners may find they are unable to put away as much as they would like with a defined contribution plan alone. Business owners wishing to increase tax-deferred contributions may wish to consider a defined benefit plan, either as a replacement for, or in conjunction with, an existing defined contribution plan.

Defined benefit plans can provide for much larger contributions, but have traditionally been too costly and rigid for many small businesses. However, the introduction of so-called prototype plans by actuaries and plan administrators have greatly reduced the costs of sponsoring a defined benefit plan, and recent tax legislation provides greater flexibility in structuring and funding these plans. 

Which retirement plan, or combination of plans, is best suited for your organization depends on many factors. For single-owner (or husband and wife) businesses, your current and future tax situation, the level and stability of earnings, and the amount you would like to set aside are some of the key considerations. For businesses with employees, added factors include workforce demographics, the nature of the business, and any specific organizational goals for the plan(s).