It's Not Too Late to Save for Retirement

A recent Gallup poll indicates that retirement savings are thetop financial worry for Americans, with 52 percent citing concernover the size of their nest egg. For the significant baby boomergroup on the cusp of retirement, this concern may be less about theincome they have available to save and more about the short timethey have left to save it.

Small-business owners with significant excess income, say$50,000 or more annually, are finding the $44,000 to $49,000 annual401(k) limit to be, well...limiting. Many entrepreneurial boomersstarting late in the game can only hope to accumulate $500,000 or$600,000 for retirement under these limits, money that won'teven start to cover a retiree's cost of living expenses, letalone finance the fishing cabin.

But there is another option. Business owners in theirfifties can leverage the high contribution limits of a definedbenefit plan to contribute up to $200,000 annually, tax-deferred,toward retirement. The defined benefit plan, which can often be setup to work in conjunction with an existing 401(k) plan, is a greatway for business owners aged 40 and older to pump up theirretirement savings during their peak earning years.

What does age have to do with it? Unlike a 401(k) plan, which isa type of defined contribution plan, the defined benefit plan haslimits imposed on the ultimate benefit that can be received.Business owners who have less than twenty years left untilretirement have relatively few years to fund toward this maximumbenefit, and thus can contribute significantly more each year.Typically, the older an owner is, the higher the resulting maximumcontribution tends to be.

What types of businesses use defined benefit plans? Professionalservice firms, law firms and physician groups are ideal candidates.Independent consultants, manufacturers' reps, multilevelmarketers and realtors are also well suited, but virtually anyprivately held business with excess earnings might benefit.Supplemental income from speaking engagements, book sales,consulting or director's fees can often be earmarked almostentirely for plan contributions.

Defined benefit plans have actually been around for decades, butthey generally required an actuary or other pension consultant tobe directly involved in the set up. The process was complicated,the timetable was long, and the plan design and maintenance wasoften quite costly.

Tax law changes in the late 1990s, along with new technology,have combined to change all that. Business owners can now set upplans directly through their own tax or financial advisors entirelyonline or by calling a customer support number and joining a webcast directed by a qualified plan specialist. A sole proprietor canbe set up with a plan in a matter of minutes, and a business withmultiple owners and employees can often get set up in just a fewhours. These types of plans are generally simple and easy tounderstand, they're quick to set up, and consequently,they're less expensive to the end consumer.

Defined benefit plans do come with some considerations, however.First, like all qualified plans, including 401(k) plans, ownersmust provide a certain level of benefits to their employees. Whiletoday's defined benefit plans are generally designed to varycontribution levels among owners to meet different financialobjectives, employees need to be provided with an acceptable levelof benefits to meet strict IRS nondiscrimination requirements. Thegood news is, they can be combined with an existing 401(k) orprofit-sharing plan, which results in total employee costs ofaround 6 to 8 percent of their annual salary.

Second, owners must intend to fund the plan at some meaningfullevel for at least the next five years. This is an inexact IRSstipulation designed to ensure that pension plans contain somedegree of "permanency." Exceptions are available for"business reasons," such as the sale of the business orthe retirement of the key person.

Finally, unlike a SEP or 401(k) plan, contributions to a definedbenefit plan aren't purely discretionary. Instead, owners areexpected to contribute a set amount or a percentage of income eachyear. If circumstances change and business owners need to altertheir contribution structure, they can always amend their plandocument.

So what happens when an owner retires? Typically, the plan isterminated and distributions from the plan are rolled over into anIRA. Withdrawals from the IRA are then set to meet theretiree's preference, subject to applicable restrictions.

If you're curious about just how much you can contributeto a defined benefit plan each year, this calculator will help you determine just how muchof your income you can defer to the plan.