Retirement Plans Have Become More Attractive to Small Construction Companies

By Suzanne M. Hazlett

Suzanne M. Hazlett

Many small businesses have shied away from establishing retirement plans because of the perception that they involve high administrative costs and complexity. All that has changed, and has continued to improve since 2001.

This is good news for construction in California, an industry with a substantial number of small companies. Today, a sole proprietorship or a firm with a handful of employees can set up a retirement plan with minimal expense. It's even possible to avoid administrative fees altogether.

As a result, many firms are taking a new look at retirement plans. Charles Billington, a custom homebuilder and owner of Homes for Life in Bellevue, Wash., has long thought about a retirement plan for himself and his three employees. Today, he is actively exploring the options.

Simple IRA

One of the easiest options for companies with 100 or fewer employees is the simple individual retirement account plan. What makes it so attractive to business owners is their ability to defer the maximum ($9,000 in 2004) without regard to employee participation. Furthermore, there are no tests required by the Internal Revenue Service that limit how much an employer may defer based on average deferrals and relative earnings of lower-compensated employees. The contribution limit increases to $10,000 in 2005 and will be indexed to inflation thereafter. There is also a "catch-up provision" so individuals 50 and older can make additional contributions.

Costs are limited to custodial account fees charged by the firm that manages the accounts. They range from $10 to $100 per year per employee account. The employer can pay them or they can be automatically charged to each participant's account.

Simplified Employee Pension

A simplified employee pension is an alternative for many architects, engineers and other self-employed people. An employer may contribute up to 25 percent of each employee's compensation, provided the contribution does not exceed $41,000 for each eligible employee. The employer also has complete flexibility within these limits to set the amount contributed. It is possible to skip a year or more if business is bad.

A SEP account can be established with a simple, one-page form. There is no requirement to file an adoption agreement or annual reports with the IRS. SEP accounts are available to corporations (S or C), partnerships, non-profit organizations and sole proprietors.
SEPs do, however, have some limitations. Employees cannot contribute to their SEP accounts. The employer must make all contributions. All employees age 21 and older and part-time workers must be included and the employer must contribute the same percentage of salary for everyone. Employer contributions are always 100-percent vested in employee accounts. So, if an employee quits tomorrow, she takes the entire amount in her account with her.

That being said, a SEP can still be appropriate for a sole proprietor or employer with one or two employees. A special advantage of a SEP is that one can be established and funded until the company's tax filing deadline, unlike other qualified plans.

Solo 401(k)

The one-person 401(k) plan is most suitable for firms employing only owners and their spouses. This plan allows a much larger total contribution to a tax-deferred retirement plan.

Consider a business owner at age 50 with $50,000 in income. Assume the owner would like to contribute as much as possible to a tax-deferred retirement plan during 2004. The owner could adopt a SIMPLE IRA plan and make a maximum contribution of $11,700 for 2004. Alternatively, the owner could establish a SEP IRA plan and make a maximum contribution of $12,500 for 2004. Or the owner could set up a 401(k) plan and contribute up to $28,500 for the current year.

The contribution amount is entirely discretionary each year, making this strategy very flexible. Unique to the 401(k) is the ability of the sole proprietor to take a tax and penalty-free loan as long as the loan amount does not exceed the lesser of 50 percent of the account balance or $50,000. Finally, there are no IRS filing requirements until the plan assets exceed $100,000 or a non-owner employee qualifies for participation. Therefore, the initial administrative costs will be minimal.

One of these plans may provide a simple and effective vehicle for your firm. For a more complete understanding of the opportunities, be sure to consult your tax and financial advisers.