Most employees in the United States have organized retirement plans, usually set by their employers. The employers will usually offer Traditional IRAs or Roth IRAs, among other retirement plans, as benefits to their employers. However, for the self-employed and small business owners, setting up retirement funds can be more challenging. This is because the business owner has to decide a vehicle through which he or she will invest for retirement. There are various options available to the self-employed and business owners to enable them to save for retirement. Some options are complex and risky while others are straightforward. Some of these options are:
401(K) Option and Profit Sharing Accounts
Self-employed taxpayers and business owners can use 401k plans and profit sharing accounts to set up retirement accounts. However, many business people complain that these profit sharing retirement accounts are complex and need professional consultants to prepare. They may therefore, not be ideal for small businesses that cannot afford expensive consultants.
The IRA options are much easier and straightforward for business people and self-employed individuals. The 2011 tax code allows for a business owner to contribute untaxed funds to traditional IRA or pay after-tax funds to a Roth IRA and receive IRS tax free retirement distributions up to a cap of $11,500.00 a year. A business owner can also make contributions to a SEP IRA account up to a maximum of $49,000.00 for the 2011 tax year. A SEP IRA is set such that 25% of pretax profits or income go into a retirement account (before paying taxes). This retirement plan is ideal for people who receive inconsistent incomes and profits over the years and can save more or less depending on the year’s performance. The limitation of using the IRA option is that if the business person has employees, he or she must provide the same benefits to these employees, which can be quite costly.
Sale to a Grantor Trust
The sale to a grantor trust is a more complex retirement plan and is ideal for business people who have significant wealth. In this plan, the business person gets a registered evaluator to appraise the business. The business owner then sells a portion of the business to his or her children at a significant discount to be repaid over a period of time. The portion sold to the children is administered under a trust estate. Given that the threshold for estate gifts has been raised from $1 million to $5 million for the 2011 tax year, the business owner can provide the discount without paying any taxes, as long as the discount is within this threshold. The spouse of the business owner can be a trustee of the estate and this way, he or she can have his or her health care, regular maintenance, and educational costs covered under the estate. The repayment of the business from the children’s estate can then act as the retirement plan. The estate can continue to repay these funds over a long period of time.
Another option in use by business owners is taking a loan against the business to put the borrowed funds into a retirement fund. If a business person feels that he or she lacks the discipline to invest into a retirement fund over the years, he or she can take a loan to be repaid by the business and the loan proceeds can be used to set up a retirement account. This is a risky way of setting up a retirement account, as the business may fail to repay the loan and the retirement fund is then liquidated to repay it.