Do you or your key people need catch-contributions to fill your retirement income gap? In the early years of a business much time is spent keeping business afloat. You may now find yourself behind where you need to be regarding your retirement savings.
If you’re a business owner that does not sponsor a 401(k) you may look to an IRA. Today the official catch-up contribution for an IRA is only $1000 if you have a simple plan the official catch-up contribution is $2500 often that’s just not adequate. However, your income may be too high and you will be phased out of contributing. A SIMPLE IRA allows another $15,000. However, it has some funky matching formulas that may not fit your bill.
Sponsoring a 401(k) plan allows you to add the catch-up of $5500 along with a savings of $17,500. That is four times what the IRA allows. If you’re a high income earner you may also find that still is an adequate. You may then need to also have a profit sharing plan on top of your 401(k) plan that would allow you to save $55,000 you may then wonder how costly this might be. If you are the owner, you get to provide a matching contribution to yourself. Further, your personal contributions reduce your personal tax liability. Payments to your employees are deductible on your corporate return.
What is the right plan for catch-up contributions for you?
You may not know this, but you do not have to give every a straight percentage share of contributions. Enter the specialists in plan savings design, a third party administrator (TPA). This entity has expertise is in the design and administration of 401(k) profit sharing plans and defined benefit/cash balance plans.
The law allows several different ways that you can allocate profit sharing. Many plans don’t use an expert in plan design and simply divide the profits equally amongst all participants. To simplify, we are highlighting just a couple that our businesswoman could pursue.
Here’s a quick hypothetical example. The TPA starts by using the deferral of $17,500. If you over 50 you qualify for a $5500 catch-up contribution. First we illustrate the equal shares method. In order to reach the individual max of $56,500 you would have to provide 22.3% of compensation to all employees.
The “New Comparability” method allows for different profit sharing allocations based on each employee’s classification within the plan. Each individual’s profit sharing is based on their classification and age. The future value of the contribution is determined for each participant at the plan’s normal retirement or testing age. This future value (benefit) is then compared to demonstrate that plan is not discriminatory in favor of the owners and other “highly-compensated” employees. In this case, the owner still receives a 22.3% share, but the employee allocation is reduced to 5%.
Clearly, the New Comparability allocation method is a more efficient approach to maximize contributions. This essentially triple a max SIMPLE IRA contribution. Additionally, the vast majority of the contributions are discretionary –allowing flexibility to take advantage in a good year, yet not cripple you in a down year.
You may find that you still need to save even more and ideally have the cash flow to do so. You could then use a cash balance plan depending upon your age you likely could save about $300,000. This type of design requires actuarial calculations. At the point that this type of plan would be your path to filling your retirement savings gap I would think that the cost of an actuary would be essentially nominal.
You can see that there are several different ways that you might find your catch-up contributions. It should start with a retirement needs analysis, sometimes referred to as a gap analysis. Be sure to find a qualified person to run this calculation, such as a CERTIFIED FINANCIAL PLANNER™ professional. Once armed with that need you can better evaluate which type of catch-up contribution savings format, IRA, SIMPLE plan for 401(k) profit sharing plan might fit the bill.
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