Why It's Time to Retire the 401(k)
Retiree Robert Shively spends his days on the golf course. For many, that would be a dream come true, but not quite in the way Shively does it. The 68-year-old is the cart mechanic at the Niagara Falls Country Club.
Two and a half decades ago, his then employer, Occidental Petroleum Corp., cut its traditional defined pension plan in favor of a 401(k)-type system. So instead of getting a guaranteed pension check of $1,308 a month for his 36 years as a full-time, salaried employee, the former chemical-factory worker receives $225 a month from his 13 years as an hourly employee, plus $180.16 a month from a profit-sharing plan Oxy had for salaried employees until 1994. He also has $70,000 left of the money he saved from his tax-deferred 401(k). On the days he works, Shively rises at 5 a.m. to get to the golf course. He mostly enjoys the job. But on tournament mornings, he has to be at the course at 4 a.m. A few years ago the country club switched from gas to electric carts, some of which have four 84-lb. batteries each. Every year, Shively and another worker have to lift out all the batteries and store them for winter. "Your body aches all over," he says.
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A little-publicized tax code could help save you MoneyMost individuals are unaware of a little-known tax code that's available to all investors regardless of their income or net worth.
The internal code section for this tax break is IRC 7702. One of its components refers to the tax-advantaged growth of the cash value inside of a life insurance policy. If properly structured, an individual has the opportunity to both grow their investment money and access their money (before or after age 59½) without ever paying taxes on the gains.
However, the IRS puts limits on contributions to life insurance policies because it realizes the tax benefits of the contracts.
So how can you take advantage of tax code 7702?
Five Tips on Choosing the Right Retirement Plan for Your Business
A
small business owner who decides to adopt a retirement plan for her
business has made only the first of many important steps in this
direction. The next step is to decide which retirement plan would be
suitable for the business. If you find yourself faced with such a
dilemma, use the following tips to help you make the right decision:
Can You Afford to Fund the Plan Each Year?
If
your business is new or your profits are cyclical, you may want to
choose a retirement plan with a discretionary contribution feature.
This includes SEP IRAs and profit sharing plans. The discretionary
feature allows you to choose whether you want to fund the plan in a
particular year. This can be a useful feature in cases where your
business experiences a loss or you feel that your profits are not
sufficient to allow for funding of the plan. Caution: With the profit
sharing plan, you want to be careful about not funding the plan for too
many consecutive years, as the IRS may determine that your plan is not
eligible for the tax deductions and tax-deferred treatment afforded to
employer sponsored plans.
A money purchase pension plan has a
mandatory contribution feature, which requires that you fund the plan
whether you can afford to or not. SIMPLE IRA contributions can also be
mandatory, if you choose the nonelective contribution feature, or if
you choose the matching contribution feature and your employees elect
to make salary deferral contributions.
Is the Cost of Maintenance a Concern?
The
administrative costs of maintaining a retirement plan range from very
low to very high. The least costly is the SEP IRA, because
administration is usually limited to funding the plan and reporting
contributions on your business’ tax return. The 401(k) plan is usually
the most costly because of the nondiscrimination testing which is
required. If administrative cost is an issue, work with your retirement
counselor to identify the costs that may apply to each plan, and choose
the one that you can afford to maintain.
Note: Defined benefit plans are usually more costly to maintain than 401(k) plans, but are beyond the scope of this article.
How Much do You Need to Save?
If
you have a long period over which to accumulate your retirement nest
egg, you have some degree of flexibility with respect to the type of
retirement plan that you choose. However if you are close to retirement
age and find that you have come up short of your savings goal, you may
want to consider a retirement plan that allows to you skew contribution
amounts so that the lion’s share goes to older employees, such as an
age weighted profit sharing plan. Of course, this feature would be
beneficial to you only if you are older than your employees.
Do You Want to Offer Loans?
If
you would like your employees, including yourself and your spouse (if
your spouse works for your business), to be able to take loans from
your retirement plan, then you must choose a qualified plan. This is
because SEP IRAs and SIMPLE IRAs cannot include loan features.
Do You Want to Place Restrictions on Withdrawals?
Many
employers maintain retirement plans because they specifically want to
help their employees save for their retirement. If the employees
withdraw their account balances before retirement, it defeats the
employer’s goal. If you want to place restrictions on when employees
can withdraw their balances, you would need to adopt a qualified plan
and implement those restrictions. In the case of SEP and SIMPLE IRAs,
withdrawals are made at the employee’s discretion, which means they can
be made at anytime.
Conclusion
There
are many other features to consider when choosing a retirement plan for
your business. For instance, a profit sharing plan can include a
mandatory contribution feature. As such, you want to be careful when
you choose the elective features for your retirement plan. Your
retirement counselor can help you to define the retirement profile of
your business and this will greatly assist you in choosing the most
suitable retirement plan for yourself and your employees.