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Maximizing Contributions to Employer Plans

Last Updated April 2, 2009

by Denise Appleby, CISP, CRC, CRPS, CRSP, APA

When establishing a retirement plan for a small business, there are certain key factors that must be considered so as to ensure that the right plan is chosen. One such factor is the amount that the business owner intends to contribute to the plan each year. A business owner who wants to contribute the maximum amount possible, the choice of plan is usually determined by the amount of income (compensation) received from the business for the year. In order to make the correct determination, calculations should be performed to determine the contribution amounts for the respective retirement plan.

Note: Defined benefit plans would allow for the highest amount of contribution possible. However they are beyond the scope of this article.
The following examples illustrate:

Comparison for Unincorporated Business Owner-( Catch-up Eligible) 2009 Income
Plan Type
Projected Net Profit
 
$10,000
$50,000
$100,000
$250,000
Individual-k/Solo-k
$9,293.52
$31,293.52
$40,587.04
$54,500
Profit Sharing Plan/ Money purchase pension plan
 
$1,858.70
$9,293.52
$18,587.05
$48,006.14
SEP IRA
$1,858.70
$9,293.52
$18,587.05
$48,006.14
SIMPLE IRA
$9,235
$15,385.25
$16,770.50
$20,926.25
Comparison for Unincorporated Business Owner-( Not-Catch-up Eligible): 2009 Income
Plan Type
Projected Net Profit
 
$10,000
$50,000
$100,000
$250,000
Individual-k/Solo-k
$9,293.52
$25,793.52
$35,087.04
$49,000
Profit Sharing Plan/ Money purchase pension plan
 
$1,858.70
$9,293.52
$18,587.05
$48,006.14
SEP IRA
$1,858.70
$9,293.52
$18,587.05
$48,006.14
SIMPLE IRA
$9,235
$12,885.25
$14,270.50
$18,426.25

 

Comparison for Incorporated Business Owner-( Catch-up Eligible) : 2009 Income
Plan Type
W-2 Wages
 
$10,000
$50,000
$100,000
$250,000
Individual-k/Solo-k
$10,000
$34,500
$47,000
$54,500
Profit Sharing Plan/ Money purchase pension plan
 
$2,500
$12,500
$25,000
$49,000
SEP IRA
$2,500
$12,500
$25,000
$49,000
SIMPLE IRA
$10,300
$15,500
$17,000
$21,500
Comparison for Incorporated Business Owner-( Not-Catch-up Eligible) : 2009 Income
Plan Type
W-2 Wages
 
$10,000
$50,000
$100,000
$250,000
Individual-k/Solo-k
$10,000
$29,000
$41,500
$49,000
Profit Sharing Plan/ Money purchase pension plan
 
$2,500
$12,500
$25,000
$49,000
SEP IRA
$2,500
$12,500
$25,000
$49,000
SIMPLE IRA
$10,300
$13,000
$14,500
$19,000

As is demonstrated in the examples above, an Individual/Solo-k always allows for the highest contribution amounts. However, for a business owner that prefers to adopt another type of plan instead of a 401(k) plan, SIMPLE IRAs may allow for a higher contribution amounts than the other plans when compensation is in the $50,000 range.  
Multiple Plans May Mean Opportunities to Increase Contributions
Small business owners who participate in multiple plans may be able to increase their annual contribution amounts by making the maximum allowable contribution amount to each plan. However this can only be done if the plans are maintained by unrelated and unaffiliated employers, i.e. employers that are not part of a controlled group or affiliated service group
Caution: Due to the complex nature of the rules that govern affiliated and related employers, clients should consult with an ERISA attorney for determination of whether multiple businesses with common ownership or affiliation are related/affiliated. Any violation of the rules can lead to a disqualification of plan assets.
 
The following is an example where the employers are not related or affiliated, and the business owner is therefore eligible to contribute the maximum amount to each plan.
Example: John works for ABC Corporation and participates in their 401(k) plan. His relationship with ABC is limited to that of an employee. John operates a consulting business on the side, and operates a Solo-k for his consulting practice.
John may contribute the maximum allowable amount to both plans

Caution: The salary deferral limit applies. Therefore, John’s aggregate salary deferral contribution to both plans cannot exceed $16,000 + catch-up of $5,500 for 2009.
 
The "Smell Test"- Determining if ERISA Expertise is Needed
Employers that are related or affiliated are treated as one employer, for purposes of determining the allowable contribution amounts to employer sponsored retirement plans (the annual addition limit). Except in cases where it is clear that no such relationship exists, determining if an affiliated or related situation exists can be challenging. In addition, narrowly defined exceptions apply that could result in a seemingly related/affiliated employer not being treated as such for plan purposes. If there is any doubt as to whether an employer is affiliated/related, an ERISA attorney should be consulted
 
Some Other Factors that affect choice of plan
In addition to the amounts that can be contributed to the type of retirement plan, there are other factors that may influence a business owner’s choice of retirement plan. These include the following:
·         Funding flexibility. A newly established business may prefer a SEP IRA or a profit sharing plan because of the discretionary-contribution feature . This allows the business owner to determine from year-to-year whether contributions will be made to the plan.
·         Vesting permissibility: A business with common-law employees may want participants to ‘earn’ the contributions made to their accounts. This can be accomplished by choosing a vesting schedule- for instance, the vesting schedule could require that an employee participate in the plan for five years in order to become entitled to or ‘own’ contributions made by the employer. A vesting schedule may be ideal for a business with a high staff turnover
·         Cost of maintenance: IRA based plans, such as SEP IRAs and SIMPLE IRAs are typically low-cost maintenance plans, as they do not require the services of a third party administrator and no 5500 filing is required. Qualified plans may require nondiscrimination and/or top-heavy testing, which usually requires the services of a plan professional, and form 5500 filing is required except for certain owner-only plans with balances of $250,000 and under. These services can be costly.
 
Common mistakes made with establishing and maintaining employer plans
Retirement plans are usually adopted by businesses with the best of intentions. However, mistakes sometimes happen, resulting in loss of qualified status, or missed opportunities for the business owner and participants. The following are a few of the common mistakes:
·         Small business owners with ‘Corporations’. Small business owners who incorporate their business may forget to pay themselves W-2 wages. These W-2 wages are usually the only form of income from the business that the business owner can use for purposes of determining retirement plan contributions.
·         Excluding eligible employees: Some business owners really want to cover only themselves under their retirement plan. However the governing laws include provisions which ensure that common-law employees are covered, providing they are eligible. Failure to include eligible employees can result in disqualification of the plan
·         Maintaining another plan along a with SIMPLE IRA or SIMPLE 401(k) Plan, when the defined exceptions do not apply
·         Failing to perform required updates/amendments to plans according to the new tax laws.
 
Changing Choice of Plan
There is no ‘wrong’ retirement plan type for a business owner. However, should it be determined later that the initial plan chosen was not the ideal plan type, there are ‘corrective’ measures which can be implemented. One such measure would involve terminating the current plan and rolling over or transferring the balance to the new plan.
Certain restrictions apply- for instance, after-tax amounts, and amounts representing required minimum distributions cannot be rolled over from an IRA to a qualified plan, and SIMPLE IRA assets cannot be rolled to another plan-type, until at least two-years have eapsed since the first deposit was made to the SIMPLE account.
For qualified plans that are terminated, the assets should generally be distributed within one year of the termination date. These amounts can be transferred or rolled over to another qualified plan, or rolled over to a SEP IRA or Traditional IRA.
 
Conclusion
For any Business Owner considering adopting a retirement plan for his/her business, it is strongly recommended that an analysis should be conducted to determine the features and benefits which are most important to him/her. This will help to ensure that the right type of retirement plan is adopted. Additionally, if the plan of choice is a qualified plan, the business owner should work with his/her tax professional and/or retirement counselor to determine whether additional expertise is required to help ensure that the plan operates in accordance with regulatory requirements.