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Columns: Tax Talk
George Saenz, CPA   Expert: George Saenz, CPA
Tax Talk
Qualified retirement plans permit greater contributions
Tax Talk

Plan gives owner a tax break

Dear Tax Talk,
I own a small company and I am thinking about starting a pension plan. I've been making contributions to IRAs, but the contributions won't be that much when I retire. What are the advantages of a company plan?
-- J.J.

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Dear J.J.,
A qualified retirement plan will allow you to contribute greater amounts to retirement accounts. The more you contribute to your retirement, the more your deduction, which means the bigger your tax savings.

The principal advantage of retirement savings is the tax break -- if you're saving anyway, it is better to do it in a retirement plan and save some tax dollars. It's like the IRS giving you part of the money to contribute to the plan. For example, suppose you're in a 40 percent tax bracket (federal and state) and you have $10,000 to put into savings. If you put the $10,000 into a retirement account, you save $4,000 and it's a 40 percent return on your savings. If you had just put the money into a regular bank account you would only have $6,000 left after paying taxes.

Of course there are disadvantages to a retirement plan, and they're principally in two categories: employee costs and administrative costs. Employee costs are the costs associated with giving your employees retirement benefits. The owner of a company cannot establish a retirement plan for his exclusive benefit. He has to give somewhat equal benefits to his employees.

There are ways to reduce these costs and they vary considerably depending on the type of plan you establish. Ideally your employee costs should be less than your tax savings, otherwise you're losing money. For example, if you established a plan that required you to give $2,000 to your employees when you contributed $10,000 for yourself, continuing the example above, you're still $2,000 ahead and you gave something to your employees that did not cost you anything. When raises come around next year maybe you can cut back.

Administrative costs deal with the cost of establishing and maintaining the plan. Depending on which plan you choose, your costs could be fewer or greater. A SIMPLE IRA plan is easy to establish and maintain and will have little start-up and annual costs. A 401(k) is more complex and a defined benefit plan is the costliest by far. A SIMPLE IRA can cost from nothing to a few hundred dollars a year; a 401(k) will probably be around $1,500 to start and $1,500 a year to administer. There is a tax credit you can claim for administrative costs associated with a new plan.

Without knowing the particulars of your situation, I can't recommend which plan is right for you. However, a qualified Certified Public Accountant or pension specialist should be able to help you work through the numbers.'s corrections policy -- Posted: Oct. 30, 2007
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