Actuaries Unlimited, Inc. Quarterly Digest


Small Businesses Still Need Retirement Plans


by E. Mark Fishman, Enrolled Actuary, MSPA, FCA, MAAA on June 23, 2017

You may be thinking; I have a small business, so why would I consider having a qualified retirement plan for my company? It costs money to set up and administer, and I may have to include some of my employees. Well, it makes perfect sense to have one in place. If your company is profitable, then why wouldn’t you want to consider a retirement plan? It will not only allow you to take taxable profit each year and contribute some or all of it to a retirement plan, it will also defer taxes to future years when you will really need it to live on once you retire.

Let’s face it. It’s difficult to save even if you are in a high earning tax bracket. Most of us live close to our means (and many of us go beyond that), and the more we make the more we spend. It takes lots of discipline to put away a large part of our net income after paying the essentials. Of course for many of us, the essentials can be quite large. We like to have vacations, drive nice cars and send our children to pricey private schools, which can be very expensive and almost as costly as college tuition (and sometimes more). So with our children going to post-graduate school, living at home and either not working or earning low salaries, there are lots of expenses that we parents have today which prior generations did not. Life is expensive and the more we make the costlier it gets.

So, why a retirement plan? Well, a retirement plan has many advantages. First, if your earned income is large enough, you can contribute as much as $54,000 – $60,000 (pre-tax) in a Defined Contribution Plan (401(k), Profit Sharing Plan, etc.). For those really high earners, this might help but may not be enough. With a Defined Benefit Pension Plan, you can possibly contribute up to $200,000 – $250,000 (pre-tax)  in a single year.

Say you live in California and your business net profit is $600,000 a year. As you can see from Table 1, more than 40% of your income is going to Uncle Sam.

Tax Type Marginal Tax Rate Effective Tax Rate Tax Amount
Federal 39.60% 28.91% $173,454
FICA 2.35% 3.27% $19,611
State 12.30% 9.86% $59,151
Total Income After Taxes $252,216
Income After Taxes $347,784

Table 1

With a Defined Benefit Pension Plan, contributing $200,000 in a single year can save you more than $90,000 in taxes. Take a look at Table 2 – Instead of reporting $600,000 in income, you would be reporting $400,000, thus saving nearly $100,000 in taxes. So not only are you saving money, the $200,000 you contributed to your Defined Benefit Plan would continue to grow each year.

Tax Type Marginal Tax Rate Effective Tax Rate Tax Amount
Federal 33.00% 27.05% $108,199
FICA 2.35% 3.73% $14,.911
State 11.30% 9.02% $36,075
Total Income Taxes $159,186
Income After Taxes $240,814

Table 2

An annual contribution to a company sponsored qualified retirement plan is a forced savings each year that will grow. The growth is in a tax deferred investment vehicle, so it will not be immediately taxed. This compound effect will accelerate growth over time so you end up with a much greater sum of funds at retirement than if you just saved after tax money. This is another major advantage of having funds in a qualified retirement plan.

Here is another important aspect of a company retirement plan. No one ever plans on getting sued or filing for bankruptcy, but sometimes unfortunate and unexpected events happen to us. The funds in a retirement plan, where there are non-owner employees, are considered to be in an ERISA covered plan. This type of plan is protected from creditors in the event of filing a bankruptcy or in a lawsuit. When there are non-owner employees who have benefits in a company’s retirement plan, all assets in such a plan are considered “asset protected.”  Even the owners’ funds, which may be as high as over 90% of the funds in the plan, are protected. In fact, a qualified retirement plan may still have limited asset protection when there are no non-owner employees.

I have worked with many clients over the years that have had a retirement plan for their businesses. To their surprise, their retirement plan accumulated to over $1 million, $2 million, $3 million or more. They have told me that without a retirement plan, they would have never been able to save that kind of money and that their retirement plan ended up becoming a major part (if not their only part) of their retirement income. It has had a tremendous impact on their retirement lives and how they plan to live in their golden years. They will be able to enjoy their retirement and live the same lifestyle as they did when they were in their income earning years, but with much more time to enjoy it.  So, I ask you, what’s wrong with that?

Mark Fishman is an owner and an Enrolled Actuary at Actuaries Unlimited, Inc (AUI). With his Bachelor’s degree from UCLA and Master’s degree from Loyola Marymount University, both in Mathematics, Mark started with AUI in 1982 and has been a partner for more than 20 years. He is a principal contributor to AUI’s professional relationships and has fostered the expansion of their client base through unmatched service to their clients and industry partners. Mark prides himself on developing strong professional relationships, being a creative actuary and producing the most competitive results in the business.

In addition to running a business, Mark also lectures for CPA and CFP Continuing Education Seminars and Conferences. When he is not fostering an industry-wide reputation as a go to expert in retirement plans, he enjoys attending sporting events, drinking wine and listening to the Beatles. Mark has two grown sons and lives in Sherman Oaks with his partner, Carrie.