|Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.|
Behind on Saving for Retirement? Here’s How Business Owners Can Catch Up
Successful business owners are known to be all-consumed with building their business, often investing a substantial amount of their time, energy, and money in their efforts. So, it’s not surprising that many business owners reach a late stage in life without having saved sufficiently for their retirement. The good news is that, even for business owners with a shrinking time horizon, there are several ways they can catch up with their retirement savings, taking full advantage of available tax savings and the time they have left.
For small businesses with few employees and that are heavily weighted towards highly compensated employees (the owner and key employees), the tax code affords them a few opportunities to maximize their retirement plan contributions through efficient use of their business dollars:
Safe Harbor 401k Plan- Maximum Contribution: $26,000* for Owners over 50; plus matching contributions
A Safe Harbor 401k plan is a 401k plan alternative for smaller businesses that seek to weigh their contributions more heavily towards the owners and highly compensated employees. Properly structured, employers can skirt the testing for contributions and compensation required of regular 401k plans - otherwise referred to as a "safe harbor."
These plans are well-suited for smaller businesses with less than a half dozen employees, which are weighted more towards the highly compensated. While it’s a significant step towards increasing their contribution capacity, it still leaves a considerable amount on the table.
Age-based Profit-Sharing Plan- Maximum Contribution: 25 percent of net profits up to $58,000*
An age-based profit-sharing plan is generally compared to a defined benefit plan that allows discretionary contributions. In businesses where the owners or key employees are significantly older than the other employees, it can favor the former while not being discriminatory against the latter. That’s because the contribution amount is based on projected benefits an employee can expect to receive at retirement. The closer an employee is to retirement, the higher proportion of employer contributions they can expect to receive.
Combined Safe Harbor 401k Plan and Age-based Profit-Sharing Plan
Business owners in the right situation can reach the maximum contribution limit of $58,000 more easily by combining a Safe Harbor 401k Plan with an Age-based Profit-Sharing Plan. Suppose the highly compensated employees are older than the other employees. In that case, they can make the allowable elective salary deferral, receive a matching employer contribution and a profit-sharing contribution of 25 percent up to a total of $58,000. Using age-based factors, the employer profit-sharing contributions can favor the older, highly compensated employees, although the other employees will still benefit. So, it works out to be a win-win for all.
These plans are well-suited for smaller businesses with less than a half dozen employees, which are weighted more towards the highly compensated. In most cases, the employer contributions made on behalf of the non-highly compensated employees can be offset by the tax savings realized by the higher contributions made for the total payroll. These plans do require plan design and administration by a third party, which does entail some cost. However, the benefits to the business owner, the business, and its employees invariably outweigh any costs.
*Maximum contribution amounts shown are for 2021. An additional $6,000 contribution is allowed for individuals aged 50 or older.
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