Plans for smaller businesses
Employers with fewer than 100 employees can establish what's known as a savings incentive match plan for employees (SIMPLE), which are low-cost retirement plans. This can be in the form of a 401k or an IRA. It is not subject to the rules that are normally applied to 401ks. This is intended for a sole proprietor or partnership.
The cost to the business owner for a SIMPLE plan is typically $15 per account. The traditional 401k, which has vesting provisions, has much higher administrative costs.
There are mandatory matching and/or profit sharing contributions for a SIMPLE plan. Employers must match dollar for dollar for the first 3 percent of the employee's contribution.
This is like setting up each employee with an IRA and having to make matching contributions. There is no vesting provision, however. Once the employer makes the contribution, that contribution becomes part of the employee's estate.
According to West Federal Taxation's Individual Income Taxes 2006 edition, all employees who receive at least $5,000 in compensation from the employer during any two preceding years and expects as much during the current year must be eligible to participate in the plan, although participation is voluntary. A self-employed person can also participate.
The contribution must be expressed as a percentage of compensation rather than as a fixed dollar amount.
The elective deferral limit increases under the catch-up provision for employees age 50 and over. The deferral limit for 2006 is $2,500.
Options for sole proprietors
Anyone who is self-employed as a sole proprietor or partnership should have a "solo" 401k as their retirement plan. The plan has to be established before December 31, however, which is too soon for many people to know whether they will have funds available for this plan.
The "solo" 401k makes sense for a small family business. There is a higher contribution limit, plus there is a loan provision. You can borrow money from this plan without a penalty plus additional taxes. You can loan yourself the money back.
Other retirement plans will not allow this.
Health savings accounts
One of my favorite savings and cost reduction plans is the Health Savings Account, better known as an HSA. This is where you couple a high deductible health insurance plan with a special savings account.
The contribution limits on these accounts for 2006 are $2,700 for individuals and $5,450 for families with a $700 individual catch-up provision for those over 55. Not only can these plans significantly reduce your health insurance premiums, but they also give you an additional tax deduction.
The money invested in the plan accumulates interest on a tax-deferred basis. When funds are withdrawn to pay medical expenses, the withdrawal is not taxed.
Unused contributions carry over
In six years of using an HSA, my family has maxed-out our deductible only once, and all other years we have come out way ahead by saving and carrying over amounts in our HSA. This is a great savings vehicle that is woefully underused by the self-employed.
Lower tax on International profits
One economic effect that received very little attention last year was the reduction in the tax on profits brought back from overseas corporate activity.
For one year only, the tax rate was reduced from 35 percent to 5.25 percent, and money flowed back into the U.S. from other countries to corporations headquartered here. This money has been a great stimulus to the U.S. economy, and may be even more so in 2006 as that money is put to work through corporate expansion and other expenditures.
Small business owners generally do not have a lot of overseas operations, but one way to take advantage of this is to identify which corporations are cash rich right now and pursue their business. IRS rules state that this one-time windfall cannot be used for executive compensation, so the CEOs are going to want to spend it somewhere.