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Beyend 401 small buisness owners - Jean D.

Jean.D Beyend 401 small buisness owners - Wiley & sons , 2004. - 274 p.
ISBN 0-471-27268
Download (direct link): beyond401korsmallbusinessowners2004.pdf
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Volatile versus Stable Profits?
How predictable are your profits? Does your business have up years and down years? Or, is profitability stable from
62
What Are the Options?
year-to-year? This factor makes a significant difference in what type of plan is right for your business.
In businesses with volatile profits, flexibility is important. You may need to skip making contributions for a year to fund operations. Defined contribution profit-sharing plans give you flexibility.
In businesses with stable profits, annual financial commitments make more sense. Defined benefit pension plans allow you to put more money away but lock you into a fixed annual contribution commitment.
Defined Contribution Profit-Sharing Plans
A profit-sharing plan gives you the flexibility to decide on an annual basis how much you will contribute. In 2002, employer contributions could not exceed 25 percent of total compensation of participating employees. Employer contributions can vary from year to year, and to retain qualified status must be substantial and recurring.
Table 6.15 Example of Defined Contribution Profit-Sharing Plan
• Company A has $20,000 in profits to distribute among participants.
• Allocation based on salary as a percentage of total salary.
Salary ($) Salary (%) Contribution ($)
Owner 100,000 50 10,000
Employee 1 50,000 25 5,000
Employee 2 30,000 15 3,000
Employee 3 20,000 10 2,000
Total 200,000 100 20,000
Part 2—More Complicated and Costly Plans 63
Table 6.16 Example of Defined Contribution Profit-Sharing Plan
• Company A has $20,000 in profits to distribute among participants.
• Allocation based on age.
Salary Salary Contribution
($) (%) Age ($)
Owner 100,000 50 55 15,150
Employee 1 50,000 25 45 3,350
Employee 2 30,000 15 35 900
Employee 3 20,000 10 25 600
Total 200,000 100 160 20,000
With a profit-sharing plan, you specify how the contributions will be allocated among employees, usually based on salary, service, age, or a combination of factors (see Table 6.15).
With the allocation based on salary as a percentage of total salary, the owner receives 50 percent of the contribution. If the allocation includes age as well as salary, the owner receives a significantly higher portion of the amount contributed to the plan (see Table 6.16).
Vesting
With a profit-sharing plan, the employer can establish a vesting schedule. This means that employees who leave prior to vesting forfeit their accounts.
There are three vesting options:
1. Cliff. Employee benefits vest after five years of service.
2. Graded. Employee vests gradually, for example, 20 percent per year.
64 What Are the Options?
Table 6.17 Highlights of Defined Contribution Profit Sharing
Pros Cons
Contributions are discretionary. Offered to all employees.
Flexible allocations (age, salary). Discrimination tests.
Vesting. Cost of administration.
Forfeitures reallocated to plan. Record keeping.
Contributions are discretionary.
Fiduciary responsibility.
3. Immediate. For plans requiring two years of service for participation, employee benefits vest immediately.
Cliff vesting is a good choice for companies with high employee turnover. With gradual vesting, employees who leave when partially vested forfeit the unvested portion of the benefit. Forfeitures are reallocated among plan participants based on salary and/or service, and hence tend to benefit the owner over time (see Table 6.17).
The DC profit-sharing plan is a good choice for business owners with volatile revenues because contributions are flexible and can be adjusted to the business results on an annual basis. Further, this plan works well for businesses with high employee turnover because the forfeitures benefit the longterm plan participants—the owner and key employees.
Defined Benefit Pension Plan
For the small business owner, defined benefit (DB) plans are like traditional pension plans; you know the specific amount you will receive when you retire. The contributions are calculated to achieve the desired payout.
Part 2—More Complicated and Costly Plans 65
Table 6.18 Example of Defined Benefit Plan
Plan promises 60 percent of pay at retirement at age 65.
Amount of contribution is determined by amount of benefit promised.
Participant earning $100,000 per year before retirement is entitled to receive $60,000 per year.
The contribution needed to fund this payout is calculated by an actuary based on several factors including the employee’s age, date of retirement, and financial assumptions about interest rates.
For companies with owners and key employees who are 50 or older, who want to retire in 10 years or less, DB plans are an attractive choice. If you are an older business owner, this is a great way to catch up because you can contribute (and tax-deduct) as much as necessary for an annual retirement payout
Table 6.19 Example of Defined Benefit Pension Plan
Defined
Benefit
Compensation Contribution
Name Age Service ($) ($)
Owner 53 20 200,000 137,113
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