Successful business owners are known to be all-consumed with building their business, often investing a substantial amount of their time, energy, and money in their efforts. So, it’s not surprising that many business owners reach a late stage in life without having saved sufficiently for their retirement.The good news is that, even for business owners with a shrinking time horizon, there are several ways they can catch up with their retirement savings, taking full advantage of available tax savings and the time they have left.
For small businesses with few employees and that are heavily weighted towards highly compensated employees (the owner and/or key employees), the tax code affords them with a few opportunities to maximize their retirement plan contributions through an efficient use of their business dollars:
Safe Harbor 401k Plan – Maximum Contribution: $24,000 for Owners over 50; plus matching or 3% employer contributions*
A Safe Harbor 401k plan is a 401k plan alternative for businesses that seeks to weigh their contributions more heavily towards the owners and/or highly compensated employees. Properly structured, employers can waive the testing for contributions and compensation required of regular 401k plans – otherwise referred to as a “safe harbor.”
Age-based Profit Sharing Plan – Maximum Contribution: 25 percent of net profits up to $53,000*
An age-based profit sharing plan is comparable to a defined benefit plan that allows discretionary contributions. In businesses where the owners or key employees are significantly older than the other employees, it can favor the former while not being discriminatory against the latter. That’s because the contribution amount is based on projected benefits an employee can expect to receive at retirement. The higher their income and the closer an employee is to retirement, the higher proportion of employer contributions he or she can expect to receive.
Combined Safe Harbor 401k Plan and Age-based Profit Sharing Plan
Business owners in the right situation can reach the maximum contribution limit of $53,000 more easily by combining a Safe Harbor 401k Plan with an Age-based Profit Sharing Plan. If the highly compensated employees are older than the other employees, they can make the allowable elective salary deferral ($18,000, plus $6,000 if over age 50), receive a matching employer contribution and a profit sharing contribution up to a total of $53,000. Using age-based factors, the employer profit sharing contributions can be weighted more favorably towards the older, highly compensated employees, although the other employees will still benefit. So, it works out to be a win-win for all.
Cash Balance Plans
For business owners looking to save even more than the $53,000 maximum 401k contribution limit adding or starting a Cash Balance plan to a 401k plan might be the right solution for you. Again using age based factors the plan can be designed to benefit older, highly compensated employees. When combined with the $53,000 401k limit the combination of a 401k/Cash balance plan could help an owner in his 50’s save close to $200,000. Even more for older owners, close to $300,000 for owners in their mid to late 60’s. Again contributions need to be made to non-highly compensated employees as well, but for an owner in the top tax brackets, the tax savings make up for the additional expense.
These plans are well-suited for small businesses where owners or other key employees are earning the majority of the company’s wages. In most cases, the employer contributions made on behalf of the non-highly compensated employees can be offset by the tax savings realized by the higher contributions made for the total payroll. These plans do require plan design and administration by a third party, which does entail some cost. However, the benefits to the business owner, the business, and its employees invariably outweigh any costs.
*Based on 2015 contribution limits