Retirement Benefit Plans
A financially secure retirement is a goal of all Americans. Since many of us will spend one-fourth to one-fifth of our lives in retirement, it is more essential than ever to begin preparations at an early age. Many financial planners report that an individual requires about 75% of his or her pre-retirement income to maintain the same standard of living enjoyed during one's working years.
Social Security, employer-sponsored retirement programs and personal savings are the three sources of post-retirement income.
Social Security Benefits Social Security provides retirement benefits for most persons employed or self-employed for a set period of time (currently 40 quarters; about 10 years). Benefits paid at retirement, traditionally age 65, are based on a person's earnings history. The age at which you can retire at full benefits increases depending upon your current age. For younger individuals full benefits begin at about age 67. Payments may begin at age 62 at a reduced rate or, if delayed until age 70, at an increased rate.
For a person with earnings equal to the U.S. average, the benefit will be about 40% of pay. For someone with maximum earnings, the benefit would be about 25% of the portion of pay subject to Social Security tax.
TIP: Every worker should understand Social Security retirement benefits. By completing Form SSA-7004, "Request for Social Security Earnings and Benefit Estimate Statement," you can receive a projection of benefits. Forms can be obtained through Social Security Online, local Social Security offices or by calling 1-800-772-1213.
Social Security, employer-sponsored retirement programs and personal savings are the three sources of post-retirement income.
Social Security Benefits Social Security provides retirement benefits for most persons employed or self-employed for a set period of time (currently 40 quarters; about 10 years). Benefits paid at retirement, traditionally age 65, are based on a person's earnings history. The age at which you can retire at full benefits increases depending upon your current age. For younger individuals full benefits begin at about age 67. Payments may begin at age 62 at a reduced rate or, if delayed until age 70, at an increased rate.
For a person with earnings equal to the U.S. average, the benefit will be about 40% of pay. For someone with maximum earnings, the benefit would be about 25% of the portion of pay subject to Social Security tax.
TIP: Every worker should understand Social Security retirement benefits. By completing Form SSA-7004, "Request for Social Security Earnings and Benefit Estimate Statement," you can receive a projection of benefits. Forms can be obtained through Social Security Online, local Social Security offices or by calling 1-800-772-1213.
Business Retirement Plans:Depending on whether you are a sole proprietor, a partnership or a small corporation, the following plans are available:
Designing the Right Corporate Plan Selecting the right pension plan for a corporation results from a process of identifying business needs and expectations, including
Although there are many different types of retirement plan options available to corporations, they fall into two general categories: defined benefit plans and defined contribution plans: Defined Benefit Plans. With this plan, the benefits an employee will receive are predetermined by a specific formula — typically tied to the employee's earnings and length of service. The law allows a pension of up to $160,000 a year. This figure is indexed for inflation; the 2004 amount is $165,000. The employer is responsible for making sure that the funds are available when needed (the employer bears funding and investment risks of the plan). Such a plan can provide larger benefits faster (through tax-deductible contributions) than other plans. The price of providing a higher degree of tax savings and being able to rapidly shelter larger sums of retirement capital is having to meet additional reporting requirements. Defined benefit plans typically cost more to administer, requiring certifications by enrolled actuaries, and insurance payments to the Pension Benefit Guaranty Corporation (PBGC), which may review plan terminations. Defined Contribution Plans. Also known as individual account plans, defined contribution plans specify the amount of funds placed in a participant's account (for example, 10% of salary). The amount of funds accumulated and the investment gains or losses solely determine the benefit received at retirement. The employer bears no responsibility for investment returns, although the employer does bear a fiduciary responsibility to select or offer a choice of sound investment options.
Plans Available to Non-Corporate Employers
Non-corporate employers can adopt any of the plans listed above that corporate employers can, except, of course, those based on stock in the employer corporation (stock bonus and ESOP plans). Defined benefit, profit-sharing, money purchase and 401(k) plans sponsored by noncorporate employers — that is, self-employed persons — who participate in the plans are often called "Keogh plans.
Contribution limits for unincorporated businesses are the same as for corporate plans of the same type, except for contributions on behalf of the self-employed owner — sole proprietor, partner or LLC member, who for this purpose is treated as an employee. Contributions for a self-employed owner are based on the owner's self-employment net earnings. The contribution ceiling for money purchase, profit-sharing and SEP plans are the same: in effect, 20% of earnings (technically, 25% of earnings reduced by the contribution) up to a maximum contribution of $40,000 (indexed; the 2004 amount is $41,000). For defined benefit plans, a self-employed owner's benefit is based on self-employment net earnings less deductible contributions. In plans such as 401(k)s or SIMPLEs where employees defer part of their salary, self-employed owners are deferring part of their self-employment earnings. For employees, deferred salary is excluded from taxable pay; for self-employed owners, deferred self-employment earnings are deducted. Keogh plans, like comparable corporate plans, must be established by the end of the year (December 31) for which you are making the contribution. Once established, you have until your tax return filing date - including extensions - to make the contribution. SIMPLEs generally must be established by October 1 of the year they go into effect. A SEP may be established by the tax return due date, including extensions, for the year it goes into effect. Thus, a plan effective for 2004 can be created in 2005; contributions to that plan in 2005 will be deductible on the 2004 return if designated as for 2004 and made by the 2004 return due date including extensions. Employee contributions. These are important elements of many employer plans, allowing employees to make their own tax-sheltered investments within the company plan. In many cases such contributions are "pre-tax"—that is, from salary (reducing taxable pay), as in the case of 401(k)s, SIMPLEs, and certain SEPs, called SARSEPs, formed before 1997. Pre-tax "employee" contributions can also be made by self-employed owners, in which case they reduce taxable self-employment earnings. The ceilings on such contributions are discussed above (SARSEP and 401(k) ceilings are the same). Additional pre-tax contributions are allowed for participants age 50 or over. The ceiling amount of such contributions, called "catch up" contributions (misleadingly, since the amount or lack of prior contributions is irrelevant), for 401(k)s and SARSEPs is $2,000 for 2003, $3,000 (2004), $4,000 (2005) and $5,000 (2006 and after). For SIMPLEs, these amounts are halved ($1,000 for 2003, etc.). Employee contributions may also be after-tax. That is, they are not excludable (where made by employees) or deductible (where by self-employed owners) but still grow tax-free once invested, until withdrawn. The contributions come back tax-free; only the earnings are taxed. Employee after-tax contributions may be attached to a plan, such as a 401(k), or be to a standalone plan (maybe called a savings plan) for employees' contributions alone, or with some employer match. Credit for low-income participants. "Lower-bracket" taxpayers age 18 and over are allowed a tax credit for their contributions to a plan or IRA. Credit is allowed on joint returns of couples with (modified) adjusted gross income (AGI) below $50,000, heads-of-household below $37,500 and others (singles, married filing separately) below $25,000. Credit is a percentage (10%, 20%, 50%) of the contribution, up to a contribution total (considering all contributions to all plans and IRAs) of $2,000. The lower the AGI, the higher the credit percentage: the maximum credit is $1,000 (50% of $2,000). Credit is allowed whether the contribution is pre-tax (credit is in addition to a deduction or exclusion) or after-tax. Review plan decisions. Law changes in the recent past, and changes described above that are scheduled to become effective in 2004 and after, suggest that business owners should reconsider the type of plan they provide. Plans most affected are:
Individual Retirement Accounts. An employer may establish IRAs for its employees to which the employees contribute, though this is not usual. Effective starting in 2003, an employer will be able to establish IRAs for employees within an employer plan. But virtually all IRAs are set up by the individual worker, employed or self-employed (occasionally for the worker's spouse) without involvement of any employer. An IRA is a tax-favored savings plan that allows workers to make contributions with pre-tax dollars (where deduction is allowed, see below) and defer taxation on earnings until retirement. There are several limitations to IRAs:
Questions To Ask Before Finalizing a Pension Plan
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