There's never been a better time to establish a tax-favored pension plan. The benefits are double-barreled for entrepreneurs. Setting up a qualified plan not only provides you with a tax deduction for the contributions you make on your employees' behalf, but the money you contribute to your own account is also deductible and is not included in your taxable income until withdrawn. (A qualified plan meets the requirements of the Employee Retirement Income Security Act and the IRS Code.)
On top of that, your own contributions to your account are allowed to earn interest that's tax-deferred until you make a withdrawal. "The power of compounding with pre-tax money is very powerful," says Ward Bukofsky, a CPA with Beverly Hills, California, accounting firm Braverman, Codron & Co.
Accountant Mark Cohen, a CPA with New York City accounting firm Newman & Cohen CPA PC, agrees. "We have some clients with several million dollars in their retirement plans thanks to regular retirement contributions and related tax deferral compounding."
Amassing this type of nest egg offers small-business owners a sense of security. "All businesses have ups and downs--and some don't make it,' says Joan Vines, a CPA with accounting firm Grant Thornton LLP in Washington, DC. By setting money aside in a qualified pension plan, it is safe from creditors' reach in the event your company runs into financial trouble. As a result, Vines says, "that money is going to be there even if the business is not."
The Taxpayer Relief Act of 1997 also makes it easier to set aside funds for retirement in both a company retirement plan, such as a 401(k), and an Individual Retirement Account (IRA). That's because the new law increases the income limits on deductible IRAs in stages for individuals who are active participants in a pension plan. This year, you can fully deduct a yearly IRA contribution of $2,000 if your adjusted gross income is $50,000 or less for joint filers and $30,000 or less for single filers.
Another important change: The new law permanently repeals the 15 percent excise tax on distributions from retirement plans (including both IRAs and qualified plans) that exceed $150,000 in any given year.
Joan Szabo is a writer in McLean, Virginia, who has reported on tax issues for more than 12 years.