Barbara’s Blog

According to the annual Employee Benefit Research Institute (EBRI) Survey, “employer-sponsored retirement savings plans are an important savings vehicle for American workers.” In addition to helping employees save for retirement, employees increasingly turn to their companies to inform them about retirement issues.

You can help to meet employee needs by sharing certain information.

1.    Active participation status

If your company has a qualified retirement plan covering employees, you are required to report this on W-2 forms. More specifically, active participation status of employees is denoted in Box 13 of Form W-2.

Why is this information important for employees? It tells them whether they are subject to an IRS income limitation for making deductible IRA contributions. If they are active participants, they cannot deduct such contributions unless their modified adjusted gross income is below set limits.

Even if they are active participants, they can still save for retirement using a Roth IRA. Again, income limits apply here, but being covered by a retirement plan is not. Direct employees to IRS Publication 590 for details on IRA contributions.

2.    Opt out elections

If you have an automatic enrollment feature in your company’s 401(k) plan, you must give employees the right to opt out or to reduce the default salary reduction contribution. Usually this is done at least 30 days but no more than 90 days before the start of the plan year (most small businesses run their plans on a calendar year). Find more about the opt-out feature from the IRS; this includes the notice form you give to employees.

3.    Employer contributions

Depending on the type of qualified retirement plan used by your company, you may or may not be required to make any contributions on behalf of employees. Certainly, this is information that employees want to know.

If you make contributions and plan to change them in any way (e.g., reducing the percentage used to figure your contributions; changing the timing of contributions to an annual lump sum for employees still on the payroll at that time), you must notify employees in writing. You’ll find notice requirements buried in the IRS Checklist (it may be too late for changes for 2013, but check with your tax advisor).

4.    Loan options

Your qualified plan may permit participants to borrow money from their accounts. The tax law limits how much can be borrowed and requires repayment in level amounts over a period of no more than five years (with the exception of borrowing to buy a home). The plan sets the interest rate on the borrowing.

Tell employees, through a form letter or in the employee manual:

•  Who to contact (the plan administrator) if they want to take a loan.

•  What the loan means for plan participation. Usually, they are barred from contributing while the loan is outstanding.

•  Whether interest is deductible. This usually depends on whether the participant is an owner or other key employee.

5.    Special distributions

Usually, qualified retirement plans must bar distributions until employees retire or leave the job. However, distributions can be taken earlier (without disqualifying the plan) under certain circumstances:

•  Hardship distributions can be made if a participant has a serious financial need, such as paying funeral expenses for a spouse or dependent. The distribution is taxable to the participant (and subject to penalty unless a penalty exception applies).

•  In-service distributions to a participant age 62 or older who is still working for the company. Again, the distribution is taxable to the employee, but not subject to a penalty because he or she is over age 59½ (a penalty exception).

•  Distributions pursuant to QDROs (qualified domestic relations orders) for a participant who is getting a divorce or legal separation. The court can direct that benefits be paid to an “alternate payee,” such as the spouse. Such amount is not taxable to the participant but rather to the alternate payee.

Conclusion

If employees ask questions about your company’s retirement plan or their retirement planning that you can’t answer, consult with a tax or financial advisor.

About 70% of Boomer-owned businesses are expected to change hands within the next 10 or so years, according to a 2006 article by Robert Avery of Cornell University.

Many of these owners have adult children or other relatives who work for them, and the owners may be thinking of ways to transition to retirement without a huge tax bill.

If you want your successors to own your business while you enjoy capital gains treatment for disposing of your ownership interest, follow tax rules scrupulously. Your successors can end up with 100% ownership of your corporation, you get the payout you want, and it won’t cost your successors a penny.

Here’s how the transaction should be set up:

• Assume you own 100% of your corporation (it doesn’t matter whether it’s a C or S corporation) and you have two adult children who work for you. You want them to own the business so you can retire to a nice community in a better climate and enjoy the fruits of your labor. You give some stock to each child; the amount is up to you. There’s no income tax when you give shares to your children. For federal gift tax purposes, you can give up to $13,000 worth of stock in 2012 with no tax (or $26,000 if you are married and your spouse consents to the gift).
• Now the corporation redeems all of your stock. If the corporation has sufficient cash, it can pay you the full redemption price. If not, the corporation can give you an installment note and pay you off over a fixed period (say five or 10 years).

Legal results: Following the redemption, your children own 100% of the corporation. You are no longer involved in the company (other than as a creditor if you are paid in installments).

Tax results: The redemption is treated as if you’d sold your stock to the corporation; this “sale” is taxed at the favorable capital gain rate (15% in 2012). If the corporation pays you out over time, then you report your gain over the period of the installments (unless your tax picture favors opting out of installment reporting so that you pick up all of the gain in the year of the redemption). Your children are not treated as having received a dividend from the corporation, even though they now own the entire business without any personal cash outlay.

Traps: This favorable redemption rule does not apply if you retain any interest in the business other than as a creditor (i.e., one who is owed money from the corporation). Caution is advised if you want to remain as a consultant or a board member; in some situations these positions can be considered a retained interest that prevents favorable redemption treatment. Doing the arrangement incorrectly can mean:

• You’re taxed on the proceeds as dividend income (which may not be taxed favorably after 2012 if you’re considered a high income taxpayer).

• Your children may be burdened with dividend income as well.

Because of the need to follow tax rules exactly, it is wise to work with a knowledgeable tax advisor who can help you structure the arrangement. You can also review this arrangement in a private letter ruling.

If you have a qualified retirement plan for your business, determine whether your plan is meeting your objectives and complying with the law. If you don’t yet have a plan, consider adopting one now.

Is your current plan the best one for you?

There are several types of retirement plans that a small business can use; the one to choose depends on your personal situation.

Factors to consider in plan selection (or in changing from an existing plan to a new one) include:

1. Profitability of the business (how much can you afford to put into the plan each year).
2. Number of employees (which affects the cost of company contributions and whether to use a plan that places the contribution on owners entirely or primarily on your staff).
3. The number of years to your retirement (how anxious you are to sock away as much as you can for your own retirement).

Review your plan options in IRS Publication 560, Retirement Plans for Small Business. Talk things over with your tax/financial advisor or consult with a retirement plan expert for guidance in choosing a better plan and terminating your existing one.

Are your investment choices satisfactory?

The stock market remains volatile and interest rates are at historic lows, which may make your returns look anemic. In view of these factors, do your plan’s investment choices continue to meet your needs? Work with a financial advisor to realign your plan portfolio.

Is your plan in compliance with tax laws?

Tax laws on retirement plans have changed over the past several years, particularly since the Pension Protection Act of 2006. Are you up to date? Use a checklist for your particular type of plan (e.g., SEPs, 401(k)s) to see whether you’re in compliance.

If you discover problems (e.g., you’re not covering all of the employees you should), you may be able to correct the problems with little or no penalties or other IRS charges using the Employee Plans Compliance Resolution System (EPCRS). Talk to your tax advisor about this option if needed.

You can stay up-to-date on future changes and other retirement plan developments by subscribing to Retirement News for Employers. This free quarterly newsletter reports on plan law changes, new forms, and other plan-related items you’ll want to know about.

Retirement is a choice based on personal and economic factors. For many small business owners, running a business is a way of life as much as it is a way to earn a living. But the economic downturn has certainly impacted retirement plans for about 60% of small business owners.

According to a Wells Fargo / Gallup Small Business Index poll released on October 1, 47% say they don’t plan to retire until health reasons force them to; another 41% plan to cut back but stay involved. Only 10% plan to retire altogether.

Delayed retirement
Many owners have indicated that their target retirement age has risen: 69% now say 65 or older, versus 41% in 2005 and 52% in 2007. Only 11% plan to retire before age 60, down significantly from prior polls.

Less comfortable retirement
Before the recession, eight in 10 of small business owners thought they’d have enough money to live comfortably in retirement. Now, that number is fewer than one in three. Only one third view the value of the sale of their business as a major source of retirement income; 28% do not even view it as a source.

Money isn’t everything
While the survey clearly shows that financial concerns are impacting retirement decisions, it also indicates that small business owners love what they do. More than half (51%) would continue working full- or part-time in their current business if money was not an issue and 18% would start another business.

Where do you fall on this spectrum?