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Retirement lift for owners
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December 18, 2000: 10:38 a.m. ET
Tax change may allow small business owners, self employed to save more
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NEW YORK (CNNfn) - Small business owners, frustrated that they have been able to put away only $30,000 a year toward their retirement, may soon get a break.
Congress recently repealed a provision in the tax code that prohibited small business owners from making contributions to both defined benefit plans and defined contribution plans. That change will allow them to both save more money in their retirement plans and take bigger deductions on their tax bills.
Previously, because of a rule known as 415e, small business owners and the self-employed were limited to saving 25 percent of their salary or $30,000 for retirement in profit sharing plans or 401(k) plans.
In most cases, the IRS prevented them from also setting aside funds in defined benefits plans that will pay them a predetermined amount of money once they retire.
That is about to change. As of next month, small business owners and the self-employed will be able to set aside up to $35,000 in profit sharing or 401(k) plans. In addition, the IRS will allow them to make additional contributions to defined benefit plans, which are designed to give participants annual payments of no greater than 100 percent of their pay, up to $135,000, once they retire.
The maximum amount the IRS allows an individual to set aside in a retirement account was increased to $35,000 from $30,000 when Congress repealed rule 415e.
The amount of money any one person will be able to set aside, and claim as a deduction, under a defined benefit plan can vary tremendously. This is because the size of the annual payment from the company varies depending on the person's salary while working. Also, the size of the contribution to a defined benefit plan will vary by age. Younger people will typically contribute less. Older people will have to contribute more.
It's not for everyone
Any small business owner who wants to increase their retirement savings should consult a financial professional who can help them make a decision about whether adding a defined benefit plan will be beneficial, said Debra Levine, a vice president with Boston-based Pioneer Investment Management Inc.
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It really works best for high income individuals. They have to be making at least $140,000 for them to be able to consider both a defined contribution and defined benefit plan.
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Debra Levine
vice president, Pioneer Investment Management |
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Levine pointed out that older, higher-salaried business owners will benefit most from this change, although anyone seeking additional retirement savings above $35,000 may want to see if this rule will help them achieve that goal.
"It really works best for high income individuals," she said. "They have to be making at least $140,000 for them to be able to take advantage of both a defined contribution and defined benefit plan."
However, some small business owners who make more than $140,000 may not benefit if they have several employees who are also handsomely paid because they will have to include them in a defined benefit plan. Other small business owners, however, who employ a younger, and lower paid workforce may find it will work to their financial advantage to create such a plan, she said.
Those small business owners who can employ both retirement plans may find significant tax savings, however, she said. For example, a 50-year old self-employed individual can now put $35,000 in a retirement savings account. If they can utilize a defined benefit plan as well, they may set aside up to $78,000 as well in a defined benefit program. That figure will vary depending on several factors, but Levine said $78,000 is about average for 50-year olds.
The combined retirement contributions, under this scenario, could create a combined tax deduction of $108,000. 
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