Making 2004 the year to plan for the future.

Lose weight. Keep better track of my business miles. Back-up my computer files. Invest in my retirement. It's a new year, which means it's time to start fresh and do the right thing. It's time to improve on what we did last year and build a better future. While the cliche, "Pay yourself first," may seem contrite, it's especially relevant to business owners. If you don't start planning for your retirement, who will?

As legislation governing investments continues to evolve, there's never been a better time to start realizing some of the many tax advantages to saving your hard-earned money. In this article, I briefly explain three of the leading retirement plans. Hopefully, the information will be helpful, and you will consequently consider them as a means of diversifying your well-deserved wealth. Make 2004 your year to plan for the future.

401(k)

401 (k) plans are clearly the most widely recognized qualified retirement plan. A 401 (k) plan provides business owners with an opportunity to invest funds for themselves while serving as a valuable retirement option for their employees. Furthermore, one of the attractive benefits for a business owner is that the assets within a 401 (k) are protected against personal liability, which means those funds cannot be tapped in the event of a lawsuit.

There are essentially three ways employers can channel money into a 401(k):

1. Voluntary Employee Deferral

Employees can defer up to $12,000 of annual income into their accounts (as of 2003 stipulations). Contributions are made from pre-tax earnings--a key incentive for saving. This same deferral is available to the owner as well, although some restrictions apply to those considered highly compensated. (I address this later). Additionally, employees over the age of 50 are eligible to add another $2,000 deferral as a "catch-up" provision.

2. Employer Match

Employers can opt to match employee contributions into the plan. (The Safe Harbor approach is an exception to this). Employer matches are typically a percentage of the employee's voluntary deferral up to a cap (i.e., dollar for dollar up to 3% of an employee's annual compensation).

3. Profit Sharing Contribution

While profit sharing contributions are discretionary, they are required to be "substantial and recurring," meaning they must occur often enough to support the intent of the plan. When made, these funds are distributed into each employee's account based upon some specific formulae.

Taken together, these three sources of funds comprise the inflows into employees' accounts. The funds grow on a tax-deferred basis, but are taxed at ordinary income tax rates when distributed (presumably in retirement). Of course, there are limitations to the contributions. For example, an employee can't receive more than $40,000 or 100% of their compensation (2003) in any given year. This amount includes their voluntary deferrals. The owner and other key personnel will have their deferrals further capped based on the average amount of deferrals being made by the non-key employees.

In addition, a business owner needs to consider the expense of keeping the plan in compliance with the IRS. This expense generally ranges from $1,000 per year up to $4,000 or more. When considering this plan, an analysis should be done first to determine the likely amount of deferrals the owner will be allowed compared to the cost of running the program and the desire of providing retirement benefits to the employees.

Simplified Employee Pension (SEP)

A Simplified Employee Pension (SEP) plan is most applicable to sole proprietors or small companies, especially those employing primarily family members. While restricted to a 25% payroll deduction, a business owner is permitted to contribute the lesser of $40,000 or 100% of compensation. Like the 401(k), SEP earnings are tax-deferred. This plan is similar to traditional IRAs with early withdrawal penalties, 100% immediate vesting, and participant control over the investment decisions. Unlike the 401(k), though, it is not protected against creditors or lawsuits.

Simple IRA 

Many small business owners find the Simple IRA to be a useful way of initiating a retirement plan. This plan combines the salary deferral feature of the 401(k) and the IRA status of the SEP. The tradeoff is that employers must make mandatory matching contributions to their employees' accounts in exchange for no discrimination testing (and, consequently, little to no cost for running the plan). While the employees (including the owner) can voluntarily defer up to $8,000 (2003), employers are required to match their contributions using one of two formulas:

1. Contribute 2% of each eligible employees' compensation to their respective accounts.

2. Make a 3% match only to those employees who participate.

The retirement options outlined above provide just a glimpse into investment opportunities for business owners. Before jumping into one, there is a lot more information and detail involved in analyzing each program. As it is beyond the scope of a basic overview, I have only included what I feel are the most important points. Therefore, I definitely recommend a thorough analysis of your personal and business needs prior to making a decision.

In addition to the three plans I discussed, myriad other retirement plans exist, such as ESOPs, profit sharing plans, defined benefit plans, and more. In addition to retirement liquidity and liability issues, you may have estate planning or charitable planning needs as well. Now is the time to invest in something other than your business. Among the benefits of proper planning and investing are diversification, protection from the effects of a lawsuit and adequate liquidity. The hardest part is getting started. So, move investing in yourself to the top of priorities for this year!

J. Michael McGrath, a chartered retirement plans specialist, is a financial advisor for Valencia-based Cirrus Wealth Management. You can reach him at [e-mail] or 800-550-1095.