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401(k) Plans: What Small Business Owners Should Know

by Ray Shojinaga, guest writer for Bell Investment Advisors

March 2012

Introduction by Jim Bell, CFP®, President and Founder, Bell Investment Advisors

For many years, Bell Investment Advisors has enjoyed a very special and effective relationship with Ray Shojinaga, President and Owner of Flynn, Shojinaga & Associates, a third party administration firm in Alameda, California. Ray has done an excellent job taking care of our business retirement plans over several years as we have grown and our needs have changed. These needs have included a custom-designed 401k Plan, a Cash Balance Plan, and most recently an Employee Stock Ownership Plan (ESOP). Ray understands the concerns of small business owners because he is one himself. He listens attentively, communicates well, and he executes creatively. He has worked successfully with many of our clients who are business owners by providing custom-tailored retirement plan solutions for them and their employees. We invited him to share his expertise with you as well.  

 

Successful business owners are experts in their chosen field. They typically identify and develop certain proficiencies that provide their organization with a competitive advantage over their peers. These proficiencies may include a unique product, a specialized skill, or critical knowledge that they are able to convert into economic success for their organizations. With success comes growth, and with growth inevitably comes the need to establish a retirement plan for the employees of the business and for the business owner or owners as well.

The 401(k) as a Tool of Recruitment and Retention

Successful business owners come to understand that the recruitment and retention of key and qualified personnel are critical factors to the continued growth and profitability of their organization. The 401(k) plan, sometimes viewed as just another costly employee benefit, becomes an important tool in the recruitment and retention of key personnel, and one of the business owner’s best tools to reward the employees that have contributed to the growth and financial success of the organization. A 401(k) plan can be designed to provide the foundation of retirement savings for the majority of the employees while providing additional contributions to the retirement accounts of targeted key employees.

The 401(k) as a Significant Opportunity for Both Owners and Employees

Successful business owners invest more time and energy and take on more risk than any other employee of the organization. As the organization grows and as the financial success of the business becomes more consistent, business owners should use this opportunity to provide meaningful retirement benefits for their employees while also setting aside significant retirement income for themselves. Converting the current financial success of the business into repayment for the time, energy, and capital invested by the business owner is an opportunity not to be missed. Converting current business profits into tax deductible contributions to an IRS-approved retirement program that benefits both the employees and the business owner is a win-win opportunity. Making the decision to fund employer retirement contributions is an opportunity to reward the current employee base. Since these retirement benefits can be subject to a vesting schedule that can run as long as six years for full vesting, these annual retirement contributions/rewards can also be used to retain these important, qualified employees.

Leveraging the Value of the 401(k)

Successful business owners focus their limited resources on the growth and success of the enterprise. As a business enterprise begins, and before it becomes profitable, 401(k) plans rarely include employer contributions. As profitability of the business becomes sustainable, business owners seek the best ways to invest these profits. Reinvesting some of these profits into the employee base that drives the growth of the business is an important factor in the continued success of the enterprise. Reinvesting in employees can take many forms, including higher compensation, additional education and training, and/or additional retirement benefits. Business owners who make the decision to reinvest in and reward their employees through the provision of employer-funded retirement contributions should leverage this decision to set aside retirement income for themselves as well.

Under IRS-approved retirement plans designed to provide meaningful retirement contributions of 3% to 5% of pay to eligible employees, business owners may be able to set aside up to $50,000 for their own retirement benefit on a tax-deferred basis. For an employee earning $50,000 per year, an employer contribution equal to 3% of their pay accumulates to over $19,000 in 10 years and over $55,000 in 20 years (based on a 6% projected rate of return). If the employer contributes 5% of pay, the employee accumulates almost $33,000 in 10 years and almost $92,000 in 20 years.

To further motivate business owners to provide additional retirement benefits for their employees, the IRS will allow a business owner to contribute up to $50,000 to their own retirement account in 2012 and will allow the business to take this retirement contribution as a deductible business expense. Of course, the IRS has complex rules that must be adhered to and complied with if business owners want to leverage the meaningful retirement contributions being provided to employees into substantial retirement contributions for themselves.

Maximizing the Benefits of a 401(k) Plan to the Business Owner and Key Employees

Successful business owners can adopt IRS-approved Qualified Retirement Plans specifically designed to benefit the business owners and other key employees while providing the desired meaningful retirement contributions to the overall employee base. Retirement programs do not need to be the “plain vanilla” basic 401(k) plans with which many business owners are familiar. 401(k) plans can include Safe Harbor designs, matching contributions, even different levels of employer contributions to different groups of employees.

For business owners wanting to provide even larger and more substantial retirement benefits, a Defined Benefit Pension Plan can be considered. While employer contributions to a 401(k) plan are often capped at the lesser of 25% of pay or $50,000 per person, defined benefit pension plans can generate tax-deductible employer contributions that exceed 50%-75% of the business owner’s pay! These pension plans are very complex and require the expertise of a pension plan consultant and actuary.

For business owners with the goal to provide employees with the opportunity to participate in the growth and prosperity of the business, an Employee Stock Ownership Plan, or ESOP, may be the right retirement program. The ESOP allows employees to become stockholders of the company. The ESOP enables employees to share in the profitability and growth of the company as the value of the Company Stock that they own under the plan increases.

Reviewing the goals and objectives of the business owner and identifying which retirement plan, or combination of plans, will work best to meet these goals and objectives requires specialists with expertise in the pension planning field. Retirement plan consultants are experts in the field of designing and administering qualified retirement plans and they should be an important member of the business owner’s team of advisors.

Qualities of the Successful Retirement Plan Consultant

The successful retirement plan consultant must be able to listen carefully to the business owner and to the owner’s tax and financial advisors in order to understand the goals and objectives of the business, and be able to communicate clearly with all relevant parties as needed. The successful retirement plan consultant works to update and educate the business owner on the retirement plan opportunities appropriate to the owner’s situation. The business owner should expect their retirement plan consultant to design the best retirement program possible to meet their current goals, and to have the expertise to modify the program as objectives for the retirement plan evolve and change over time. The retirement plan consultant should remain actively engaged with the business owner throughout the life of the business. A successful retirement is the ultimate goal of a successful business.

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