August 2003

Expanded Contributions for Small Business Owners

By Douglas Smith

Early planning for retirement is sound advice for anyone. But recent changes in the tax laws have made it more important than ever that self-employed professionals and small business owners begin now to plan their retirement investments for 2003.

Expanded Defined Benefit Plans

The tax law of July 2001 has provided small business owners and self-employed professionals with a golden opportunity, by permitting an increase in their accumulation of retirement assets through the use of defined benefit retirement plans.

Specifically, the new law permits high-income, self-employed individuals and owners of up to five-person businesses to shelter up to $160,000 per year for their retirement, depending on the plan. This is much more than the $40,000 annual maximum previously allowed. The change comes as welcome news to many, but especially to older workers who have discovered that they simply have not set aside enough assets to assure a comfortable retirement.

Many self-employed and small business owners can contribute more money to a defined benefit retirement plan. The increased deductions can create significant savings on 2003 tax returns. Such savings could also potentially compensate for investment losses caused by the recent market downturn.

Developing a Plan

Choosing the best defined benefit plan can be a challenge. In the past, most defined benefit plans were customized to meet the business owner’s specific needs. However, the legal complexities and the costs of such plans sometimes became a barrier to self-employed and small business owners. Flexibility in investment vehicles was often lacking. Higher administration fees also discouraged single-owners.

Recently, however, cost pressures have increased the relative appeal of “off-the-shelf” defined benefit plans. This type of plan offers the same benefits of tax deduction and sheltering for retirement planning as customized plans do. But these plans can be more appealing to small business owners and entrepreneurs not only because of the increased investment option flexibility, but also because of their lower initial cost and administrative maintenance, due to the lack of customization and legal fees.

The “one-size-fits-all” approach can maximize tax-deferred retirement contributions while still employing conservative assumptions. This is especially important for older employees that must rely upon high contributions to “catch up” at a faster rate.

When choosing a defined benefit plan, these additional plan features should also be kept in mind:

In addition, the plan should enable self-employed or small business owners to determine the percentage of their current compensation that they want to designate as a retirement benefit; calculate the amount of savings needed to fund their retirement benefit; and, subsequently, determine how much tax-deductible funds must be contributed annually to achieve their retirement goals. Many restrictions can apply, and the size of the deduction is influenced by several variables, including the plan participant’s age and the assumed rate of return.

Self-employed or small business owners that would benefit most from such a plan would typically be 45 years of age or older and earn at least $75,000 annually. To fully benefit from the tax law changes, such an individual should expect to continue in the occupation or business for at least three more years; should be able to contribute a substantial proportion of her earned income to the plan each year until retirement; or should belong to a dual income household where a second income provides discretionary funds for investment.

Douglas Smith is the senior vice president, Metavante Wealth Management. He can be reached at (800) 829-8272 or

William Bregman, CFP, CPA/PFS

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