I think a lot about 401(k) plans and how they can be best used to help a private business owner reach financial independence. When I speak before advisor groups whether they are financial professionals, attorneys or CPA’s I always emphasize that when working with private business owners it’s crucial that they understand how 401(k) plans can be used to the benefit of the owner Clients.
If a business has less than 25 employees, the advice to a private business owner shouldn’t be how much money they can put away. Instead, we should start with the following question:
If there were no rules, how much money would you like to put in your retirement plan every year?
Once that question is answered, we can then design a plan that will help our owner put away that amount of money. Here are some guidelines with different variations on retirement plans that can be used. I’m assuming that our client is between fifty and fifty-five years old.
Safe Harbor 401(k) plan
This plan is for the owner who wants to save up to $20,000 per year.
Safe Harbor Cross Tested Profit Sharing Plan
This plan design uses a standard 401(k) plan with a profit sharing plan where most of the contribution ends up with the owner of the company. The owner will typically have to make a contribution of 5% of payroll to their employees and will be allowed to save close to $50,000 in their own account.
Hybrid plan with 401(k), profit sharing and cash balance plan
This plan combines a 401(k) plan with a profit sharing and defined benefit cash balance plan for the owners of the company. A 50 year old plus owner can often put away as much as $150,000 per year in their plan with an average 7% cost of payroll for their other employees.
Most smaller private business owners will appreciate the flexibility in plan design when they understand what their options are. As an advisor to private business owners it’s more than useful to become an expert in retirement plan options from the business owners point of view.
Finding a good third party administrator is key to presenting these plans. If you administrator understands owner’s goals, it’s easy to demonstrate that it’s not what the law allows, but how much your Client wants to save.
As always, I appreciate your feedback.