401k plans are a great tool for small business owners to achieve their retirement goals. But let’s not put the cart before the horse.
The first question to ask is:
SHOULD YOU EVEN SET UP A SMALL BUSINESS 401K?
The answer to this question is “it depends”.
Every small business owner has different goals. Maybe their goal is to provide a benefit for their employees. Maybe it’s to provide themselves with a vehicle to fund their personal retirement. Maybe it’s to minimize taxation. Or maybe it’s a combination of all three.
Other goals revolve around when a business owner will retire (if at all), their desired standard of living, and how much they need to save (if any at all).
It’s these types of issues that need to be addressed in order to determine if you should set up a 401k. We’ll discuss more about this in a moment.
IS A 401k EVEN THE RIGHT CHOICE?
We’re all familiar with 401k plans, but did you know that it’s just one of the many types of company retirement plans that exist? In fact, there are over 20 different types of plans that you can establish at your business.
Maybe a 401k plan or company retirement plan is not even the right choice for you. Maybe an individual retirement account such as a Roth IRA, Traditional IRA, or non-IRA account is best. Maybe no plan at all is best. Once again it all depends on the business owner’s situation and goals.
MAZE OF OPTIONS
So, how does a small business owner sort through the complex maze of retirement plan options? In my opinion, it’s best addressed with a detailed question and answer session.
We’ve all seen sales people out there who will pitch a product without really asking you questions to determine what you really “need”. This is a personal pet peeve of mine so let me share a personal story with you that somewhat highlights this.
Have you ever gone to the doctor and felt like you had to ask all the questions? This happened to me in 2007 when I broke my big toe. It was Father’s Day and I was in the backyard playing ball with my labrador retriever Baxter. Baxter wasn’t an ordinary tennis-ball-loving lab. Instead he loved to play with a miniature size basketball that I won at Six Flags. Although it was small, it was still too big for him to pick up with his mouth so I poked a large hole in it. Now I could kick it as hard as I wanted and it would stay in the yard for Baxter to chase. On this particular Father’s Day, it was very sunny. And with the amount of tree cover in our yard, it caused a lot of shadows on the ground.
At one point I went to kick the tiny basketball that was resting relatively close a maple tree. What I didn’t know was that there was a large tree root that was resting directly behind the ball. Not only was the root camouflaged by the ball it was also camouflaged by the shadows.
Immediately after kicking the ball, my big toe hit this flat-fronted tree root, which protruded about 3 to 4 inches out of the ground, head on. The jolt caused me to lose my balance and I ended up falling to the ground. Picture yourself walking up to a wall and kicking it as hard as you can. That’s essentially what happened when I kicked this root. I had kicked the tree root so hard that it bent the tip of my toe upward. The next day I went to the doctor to have my toe x-rayed and discovered that I had shattered several bones.
The doctor basically told me I had two options: fuse the bone together or have a pin put in. That was it. He didn’t give me the pros and cons of either option. He didn’t tell me anything about the long term effects of either option. He really didn’t tell me anything or offer me any sort of bedside manner. I felt as if I was a burden to him and that he needed to rush to his next patient.
In that situation, I was forced to think of which questions to ask on the spot. But I really didn’t know what to ask since I’m not a doctor. Plus, I was in major pain and probably not thinking too clearly.
TURNING NEGATIVE INTO POSITIVE
As a small business owner, that experience helped me to realize that I never want my clients to feel like I did that day. I don’t want them to feel as if they have to come up with the right questions to ask. Maybe they’re so overwhelmed by all the moving financial parts in their life that they’re too stressed to even know what questions to ask. That burden shouldn’t be on them; it should be on the professional.
When a so-called professional is short with their words and not forthcoming with information, it creates this feeling that they don’t have time for you. And that is never a feeling I want clients to experience.
So, back to the question:
HOW DOES A SMALL BUSINESS OWNER SORT THROUGH THE COMPLEX MAZE OF RETIREMENT PLAN OPTIONS?
Above, I talked about how a business owner’s situation and goals determine whether or not to set up a small business 401k plan or some other type of company retirement plan. So, let’s discuss this in a little more detail.
In my opinion everything should be driven by the small business owner’s personal retirement goal. This may sound strange, so let me explain.
A small business owner needs to understand how much they need to invest on a yearly basis in order for them to be able to retire when they want with the amount of money they want.
The reason that this is important is because the amount of money that you need to invest yearly will help us to determine the appropriate company retirement plan for you to establish.
Once we know how much you need to invest on a yearly basis, we can then start to whittle down the vast amount of retirement plan choices since different plans allow for different contribution amounts.
QUESTION AND ANSWER TIME
From there, it’s important to ask the business owner a series of questions to determine what type of plan is best for them and possibly their employees. As mentioned above, some of these questions will revolve around employees, taxes, and business owner goals. But there are also many other elements that need to be discussed.
Even though there are over 20 different types of retirement plans to establish there are many more features that can be implemented within these plans. Will you be making contributions on behalf of your employees? Do you want to integrate the plan with Social Security? As a business owner, do you want the ability to contribute as much as you legally can? Do you want your employees to have the ability to contribute? And the list goes on….
Deciphering the business owner’s goals and situation along with a detailed question and answer session is what we call our Plan Design Process. We feel it’s important to go through these steps in order to help the business owner determine the plan that is best for them and their company.
It’s hard to say whether or not a small business 401k plan or some other type of retirement plan is right for you, but I can say for certain that the decision should be based on your unique circumstances.
Stayed tuned for my next blog which will discuss the
4 SECRET BENEFITS OF SETTING UP A 401k
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Brad E.S. Tinnon
CERTIFIED FINANCIAL PLANNER™
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Photo courtesy of 401(K) 2012