How Entrepreneurs Can Put Away More Than $200,000 a Year for Retirement -- Tax-Free Consider this advice now in order to save as much as possible for later in life.
By Carol Roth
Opinions expressed by Entrepreneur contributors are their own.
You work and you work and you work, and you save, but it never feels like you're stashing away enough money. There are always so many expenses it can become overwhelming.
But fear not. There's at least one way entrepreneurs can save a significant amount of cash for retirement. Let me explain.
There's been a slew of legislation that is punitive to small-business owners, from minimum wage increases throughout the country to the so-called Affordable Care Act. The tax code isn't much better, and with many entrepreneurs using pass-through entities that have them paying tax at a personal income tax rate (vs. corporate income tax rate), any future corporate tax reform is not likely to affect the average entrepreneur favorably.
Related: A Crash Course on Licenses, Joint Ventures and Partnerships
However, there is one part of the tax code that is favorable for entrepreneurs and that's around tax benefits for retirement savings. While many entrepreneurs understand the basics of 401(k)s, many of them don't realize that they, depending on the earnings of their business, may be able to put away six-figures a year for retirement, tax free.
Here is some information to help you get started, directly from the experts that I myself use.
If a small-business owner isn't happy with his or her existing retirement plan or doesn't have a plan, the first step is, "to consider what their objective is for the retirement plan," says Sam Schroeder, president of ARS, an Illinois-based third party administrator (TPA) that helps small- and mid-size businesses establish, test and manage compliance related to retirement plans (including that of my own firm). "Is it to save for themselves or to offer their employees a savings vehicle? This will help guide them to a retirement plan that is a fit for their objectives."
Once you have a sense of your objectives, you can speak with your accountant and a TPA about what types of plans are a fit. While traditional 401(k) contributions are limited annually ($17,500 for 2014, plus a catch-up contribution of $5,500 if you are 50 or older, and $18,000 and $6,000 catch-up, respectively for 2015), other plan types can help you save far more. Schroeder says that using a 401(k) Profit Sharing Plan, you can put away up to $52,000 tax-free for 2014 (or $57,500 if you are over 50) and $53,000 for 2015, depending on the earnings of your business for the year (which, Schroeder notes, are limited to 25 percent of compensation).
Schroeder also says that if you use a Defined Benefit and/or Cash Balance Plan structure, the amounts that you can put away are much greater, noting that, "the total benefit that one person can receive for 2014 is $210,000," tax-free.
Again, the amount that you can and should put away this year depends on a number of factors related to you and your business, and your desire to tie up that much money in a retirement account, but if you are going to have an investment account or save for retirement, these plans can be very helpful to you as an entrepreneur.
Related: When You Should Work for Free (Yes, Seriously)
In addition to having your accountant guide you through tax implications and the third party TPA helping set up your plan and helping with compliances services -- such as filings with the government, required annual testing and distribution of other related written materials -- you may also need an investment advisor or investment company to help you allocate monies into ultimate investments.
Most entrepreneurs and small-business owners will most likely not have the services of investment companies, advisers and TPAs bundled together, and that you can benefit from the flexibility from being able to choose each of the service providers that best meets your needs, Schroeder says.
In choosing the best service providers, the TPA choice is particularly critical, as legislation relating to retirement plans changes frequently with the unfortunate whim of political tides. "Very valuable, but less well-known options under a retirement plan will go a long way in ensuring that a small-business owner receives as much benefit from their retirement plan as they can, while maintaining the qualified status of the plan," Schroeder says. "One such option is a method of allocating a profit sharing contribution called cross-testing. This requires additional testing, but enables the contribution that the small business owner receives to be greater on a percentage basis than the contribution that the employees receive."
Plus, Schroeder warns to check as you would with any other service provider to see who will be performing the work and to beware of low-cost fee traps that seem like a bargain today but may be costly at the end of the day. "Some TPAs have lower-level staff preparing important documents and testing, which increases errors and needed corrections…It would not pay off long-term to be short-sighted on fees. IRS and DOL audits can go back many years, even to plan inception if there are problems."
Barry Itzkowitz, a CPA and director with Midwest-based accounting firm SS&G (whom I also work with personally), says that you need to be focused on timing. "In order to take advantage of tax deductions for the calendar year 2014, most retirement plans must be in place before December 31st," he says. "Planning before year-end will provide valuable insight about current tax savings strategies for your business while estimating future retirement benefits for both you and the employees. Also, recent IRS limits have increased the funding limits for both 401(k) and employer contributions for 2015, so future benefit options can be considered if the December 31, 2014 implementation deadline is not met."
Focusing on your qualified retirement plan may not seem like the obvious place to spend your time in business, but it can be quite valuable to you and even to your employees. Make it a plan to check in on your "plans" for the future.
