Business owners and retirement: the bigger picture
Northwestern Mutual Life Insurance Company
As a financial adviser I meet with business owners to hear about many things that are on their mind. Here are a few topics that come up:
• How do I pay less in taxes?
• How much should I carve out of my business to fund retirement?
• Is it worth giving my employees retirement benefits?
I understand that your business is usually one of your most important assets. The cash flow that it produces and the assets you are building are probably going to be worth more than any retirement account, so why save outside of it? The number one reason is diversification. I understand you know your business, and if you only put your money into that next piece of equipment, it will pay itself off in just a few years. But most businesses are like a roller coaster, with good years and bad. Diversification will give you confidence that you are building something outside of your business that could be valuable down the road.
The second reason is that you can minimize taxes. Business owners have options, so I will discuss four that come up with my clients:
1. Simple Individual Retirement Arrangement: With a Simple IRA, the company promises to match 100 percent of the employee’s contribution up to 3 percent of base salary. A lower matching percentage is allowed, provided the percentage is not less than 1 percent and the reduced percentage is not used in more than two calendar years during the five-year period ending with the calendar year the reduction is effective. The employee can put in any amount of his salary up to $12,000 and you just match the 3 percent. Remember, as an owner if you pay yourself a salary, you are an employee so you can also put away the $12,000 a year. For example, if you pay yourself $70,000 a year, you, as an employee, can contribute the maximum amount of $12,000 and the company is allowed to put in 3 percent, which is an additional $2,100. When you take money out it will be taxed, yet no tax is due during the time it grows. Any contributions from the employer to the Simple IRA on behalf of the employee are tax deductible for the company. Some employees may choose not to contribute. In that case, you, as the employer, do not have to contribute the match for that employee.
2. A Simplified Employee Pension Individual Retirement Arrangement (SEP IRA): I generally only recommend this if you and your spouse are the only employees of the company. The reason is because the company is the only contributor and what it does on a percentage basis for one employee it has to do for all. The company can put up to 25 percent with a cap of $52,000 of your salary into a SEP IRA, which works for the business owner and their spouse. The main advantages of the SEP IRA include minimal paperwork and expense, minimal tax filing and no requirement to make ongoing contributions.
3. 401(k): This is a good option if you have a large company or you would like to contribute much more than allowed in the Simple IRA. An employee can contribute up to $17,500 or, if over age 50, an additional $5,500 catch-up contribution may be made. In turn, the company can put in an additional $34,500. However, there are rules about funding, higher expenses, compliance testing and government reporting.
4. Cash Value Life Insurance: The main purpose of life insurance is to provide a death benefit. However, there are also living benefits that cash value life insurance can offer. You are valuable to your business, so your business can get a cash value life insurance policy on you. A benefit to the business owner is that you can decide who you would like to insure and who to fund a policy for. These products also have tax advantages.
I hope this sparks a few ideas for your future. As with all financial matters, talk to a professional who can help you align your business objectives.
Michael A. Davis, CLU®, CFP® is an insurance agent of The Northwestern Mutual Life Insurance Co., Milwaukee, Wisconsin.
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