The day-to-day challenges of running your business can make it easy to forget about funding your future. But, remember, contributions to qualified retirement plans reduce your taxable income.
There are not many win/win situations in business or in life, but a qualified retirement plan comes close. A properly structured and administered retirement plan can trim your tax bill, achieve tax-free growth for your investment dollars, and provide a valuable benefit to you and – if you choose – to your employees.
What is a “Qualified” Plan?
A qualified retirement plan is an arrangement that meets certain requirements of the Internal Revenue Code and is therefore qualified for specific tax benefits. Examples include the 401(k), 403(b), IRA, Roth IRA, and a number of others.
Of particular interest to many small business owners is the Simplified Employee Pension Individual Retirement Arrangement, or SEP IRA. The plan is an effective retirement planning tool for the owners of sole proprietorships, S or C corporations, LLCs, and other business entities.
The SEP IRA is a variation of the IRA familiar to most investors. You can implement an SEP IRA to provide retirement benefits for both yourself and your employees, and funds can be invested the same way – mutual funds, stocks, bonds, precious metals, etc. – as in any other IRA.
Advantages of the SEP IRA
- Your contributions to an SEP IRA are generally 100% tax deductible, which means your taxable income – and tax liability – for the year is reduced.
- The limits on annual contributions are fairly generous. For the 2012 tax year, you can contribute up to 25% of total compensation (salary, commission, bonuses, etc.) or $50,000, whichever is less.
- Contributions are also flexible. You don’t have to make the same contribution each year, or any contribution at all, for that matter. You can raise (up to the established limits) or lower your contribution based on business and personal circumstances.
- Investment earnings in your SEP account grow tax deferred. You won’t have to pay capital gains taxes as the investments grow. Later, withdrawals from the account – after age 59½ – are taxed as ordinary income.
- Administrative costs are low, compared to some other qualified plans. In fact, your company may be eligible for a tax credit to help cover the costs of starting and running the plan for the first three years.
- For you, the SEP IRA will involve minimal reporting requirements. The financial institution your hire to run your SEP (collect and invest contributions, track account performances, enable withdrawals, etc.) will report contributions and activity summaries to the IRS and to you and other plan participants.
- If you tend to procrastinate, you’re in luck. You still have time to arrange and contribute to an SEP IRA for the 2012 tax year! The deadline is April 15th. If you haven’t implemented an SEP plan, talk to your financial advisors about other options and resolve to get the right program in place by April.
Disadvantages of the SEP IRA
Of course, the SEP IRA is not perfect. There are limitations and drawbacks to this kind of qualified plan. These include:
- Once your contributions go into the SEP, it’s supposed to stay until you’re in retirement mode. Unlike some retirement plans, there are no loan provisions for SEP IRAs.
- You can elect to withdraw funds early, but you’re subject to normal tax consequences plus a 10% penalty on distributions prior to age 59½. (But there are exceptions for death, disability, excessive medical expenses, higher education costs, and a few other special circumstances.)
- On the other hand, at some point you must start withdrawing funds, whether you’re ready or not. Minimum withdrawals must begin prior to April 1, the year after you turn 70½.
Getting Started with a SEP IRA
Consult with an investment professional to make sure an SEP IRA is the right choice for your retirement plan. He or she can help you decide what makes sense for you and your company.
Whatever you decide, be certain to choose investments that can perform well over the long term.
Finally, make sure to make consistent contributions. Invoice factoring and other small business funding services from MP Star Financial can help make sure you have enough cash on hand.
MP Star Financial’s invoice factoring services can help ensure you have cash flow needed to run and grow your business. Call MP Star Financial for more information about invoice factoring at (800) 833-3765, extension 150.