When most people think of pension plans, they think of large companies
rewarding long time employees with a monthly pension payable for life. Pension
plans, however, are also an excellent, and often overlooked, way for sole
proprietors, partners, and small business owners to gain tax savings far in
excess of the $30,000 per year permitted under most qualified retirement plans.
The small business pension plan works essentially the same way as pension
plans for larger companies. Each year, an actuary looks at the ages and salaries
of the participants and the amount of money already in the plan, and using
reasonable economic assumptions, determines a minimum required and maximum tax
deductible contribution. For a one person business just starting out in 2000,
the maximum contribution will be based solely on the age and net compensation of
the owner. The following chart summarizes the level of permissible deposits
for that individual:
|
Maximum Contribution as a % of pay |
|
|
Age on July 1, 2000 |
Earned Income* |
W2 Pay |
Maximum Dollar Contribution |
| 40 |
38% |
61% |
35,700 |
| 45 |
52% |
108% |
63,100 |
| 50 |
56% |
127% |
79,100 |
| 55 |
54% |
116% |
101,000 |
| 60 |
51% |
102% |
103,100 |
*Earned Income represents net schedule C income for sole proprietors
after reducing for the self employment tax.
For example, if you are 50 years old and you earn $100,000 of "net"
self employment income in 2000, you can contribute 56%, or $56,000 to a Defined
Benefit Plan. If your earnings are higher, you can still contribute 56%
until you hit the dollar maximum contribution of $79,100. By
comparison, under a Defined Contribution (Profit Sharing / 401k) Program, the
maximum contribution is 20% of "net" self employment income, 25% of W2
pay for corporations, up to a maximum of $30,000.
Please note that if you have been in business for more than this year, the
maximum contribution you can make may even be higher than those shown. Also,
for the first time in 2000, contributions which you have previously made to
profit sharing, money purchase, or SEPs will not count against you. In some
cases, you can even have a pension plan in addition to other types of retirement
plans.
Contributions will fluctuate from year to year based on changes in salary,
employees, and plan terms. Investment experience will also impact on plan costs.
Since contributions are not discretionary, it is important for anyone
maintaining this type of plan to communicate on a regular basis with the
actuary. As long as the actuary is kept up to date on your goals, changes can
be made to the plan to make sure that it continues to conform to your
objectives.
If you are interested in seeing how a pension plan would work for you, please
try our free Express Study.
