Software Club 210: Light Red/Club_Software_210_Light_Red_Micro_Star_1997.iso/sba/f401.sbe

Text File | 1997-01-13 | 64KB | 1,309 lines

@1044  CHAP 8

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       │  PENSION AND PROFIT SHARING PLANS AND IRA'S  │
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Qualified retirement plans (pension and profit sharing
plans) are the last great tax shelter.  If you run a small
business that is generating profits that you don't need to
reinvest in the business or to live on, socking away as
many dollars as possible into a "qualified" pension or
profit sharing plan or into an IRA (Individual Retirement
Account) can be a winning proposition, for several important
reasons:

  . The money that you (or your corporation) put into
    the plan or IRA is currently tax-deductible for
    federal and state income tax purposes.

  . Once the money is contributed to a retirement plan
    trust or IRA, it can be invested and can compound
    tax-free, until you begin withdrawing it (voluntarily,
    after age 59 1/2, or required withdrawals after age
    70 1/2).  That is, dividends or interest earned on
    the retirement fund, or capital gains on stocks or
    other investments, are not taxable to the retirement
    plan trust or IRA account, as a rule.

  . When you do begin withdrawing funds from your plan or
    your IRA at retirement age, you may be earning less
    income overall, and thus may be in a lower tax bracket
    when you finally start to collect your pension.  (Of
    course, no one knows the future, so there is always the
    risk that income tax rates in general could be much
    HIGHER when you retire than now.  Even so, you will
    still probably come out far ahead if your retirement
    assets have had the opportunity to compound and grow
    tax-free for 20 or 30 years until you finally retire
    and have to pay tax on amounts distributed out to you).

  . Also, with qualified plans other than IRA's, there are
    presently some fairly significant tax benefits, in the
    form of lower tax rates, if you take all your pension
    or profit sharing plan assets as a single "lump sum,"
    since the tax law permits you to compute the tax on
    such a lump sum under a very favorable 5-year averaging
    method.  (However, Congress repealed this favorable
    lump sum averaging treatment, as part of 1996 tax
    legislation enacted in August, 1996.  After that date,
    only certain older individuals born before 1936 will
    be eligible for an older form of 10-year averaging
    that was generally allowed up till 1986, which was
    "grandfathered" at that time for those older taxpayers,
    who must still use the 1986 tax rate tables to compute
    the 10-year lump sum averaging, if it is elected.)

  . While one of the main drawbacks of putting money into a
    retirement plan is the fact that you will not ordinarily
    have access to that money until you are age 59 1/2
    (unless you die, become permanently disabled, etc.),
    you may be able to borrow up to $50,000 from your
    retirement plan account in certain instances, at least
    in the case of a plan maintained by a corporation other
    than an S corporation.  Thus you may still retain some
    access to the funds, within strict limits:  No loans to
    your business, must pay fair interest rate on the loan,
    provide adequate security, and must repay the loan over
    a 5-year period, except for a loan used to acquire a
    principal residence).

At a time when real estate and most other kinds of tax
shelters of the type that flourished in the past are either
a dead letter or are extremely limited, pension and profit
sharing plans are an extremely attractive, low-risk option
for small business owners, since the money placed in
such plans can be invested in a fairly wide variety of
investments, including stocks, bonds, money market funds,
CD's, and other passive types of investments.  Some limited
investments in UNLEVERAGED real estate are also possible.

DON'T be misled into thinking that money you put into a
retirement account is tax-free.  While you may get a
deduction or be able to exclude the amount put into a
plan from your current taxable income, what you are really
getting is a DEFERRAL of taxes until you retire, die, or
otherwise withdraw funds from your IRA or other retirement
account.  This deferral is still quite beneficial, of
course, since you not only defer tax on the money you put
into the plan, but also on all the investment income
and gains on such money, until you finally receive your
retirement benefits.  Put it this way:  If you have a
choice of receiving a $10,000 bonus and paying tax on it
today, and then paying tax on any interest you earn on
that money from now on as well, versus having it put in
trust for you and invested at interest, and paying tax on
the $10,000 (plus whatever it has grown to from investing
it) 30 or 40 years from now, which do YOU think is a
better deal, tax-wise?  Time is money, and deferring
income taxes for several decades can be almost as good as
paying no tax at all.

NOTE REGARDING STATE TAXATION OF RETIREMENT INCOME:  On
January 10, 1996, President Clinton signed legislation that
forbids states from taxing the pensions of former residents.
This has been a major problem for taxpayers who earned
pensions in high-tax states such as California or New York,
but retired to low- or no-tax jurisdictions such as Florida,
Nevada, or Texas, only to find that the state of their
former residence was still seeking to find them and subject
their pension income to California or New York income taxes.
The new legislation prohibits those states, as well as a
number of other states that had done so, from taxing the
retirement income of non-residents, including income from
both qualified retirement plans and certain nonqualified
deferred compensation plans.  This is a major win for
taxpayers, and makes retirement plans even more advantageous
as tax deferral vehicles.  The new law is effective for
amounts received after December 31, 1995.

The key characteristics of all the major types of retirement
plans, of which there are many, are discussed below.


INDIVIDUAL RETIREMENT ACCOUNTS (IRA'S)

The simplest form of retirement account you can set up is
an IRA.  You can quickly and easily open an account with
almost any bank, saving and loan, mutual fund company, or
stock brokerage firm.

The main advantages of the IRA are:

  . Simplicity.  It usually costs nothing to open up
    an IRA or to maintain it, although most stockbrokers
    and mutual funds will usually charge a small setup
    fee of $25 or so, as well as an annual maintenance
    fee of $10 or $15.  Banks, S & L's, and other financial
    institutions rarely charge any such fees.

  . You don't have to cover any employees.  For all other
    types of retirement plans, if your business has
    employees, you must also contribute money to the plan
    on their behalf, as well as for yourself.  There is
    no such requirement for a regular IRA.

  . You don't even have to be in business, or making a
    profit, to set up an IRA and make tax-deductible
    contributions to it.  As long as you have earned
    income from some source, whether it be your business
    or a job with an employer, you can make IRA
    contributions.

The drawbacks to the IRA are:

  . You are limited to an annual contribution to an IRA
    of $2000 (or $4000, if you have a non-working spouse,
    and you contribute at least $2000 to a separate IRA
    for your spouse).

  . Even this limited contribution amount will not be
    deductible, if you are covered by any other kind of
    qualified pension or profit sharing plan and your
    adjusted gross income ("AGI") exceeds $50,000.  The
    deduction begins to "phase-out" when income exceeds
    $40,000, or, if you are not filing a joint return,
    you lose the IRA deduction if your AGI exceeds $35,000
    (with the "phase-out" starting at $25,000 of AGI).

  . You may be able to withdraw funds from an IRA before
    age 59 1/2 without incurring the 10% pena