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Beyond 401(k)s for Small Business Owners
A Practical Guide to Incentive, Deferred Compensation, and Retirement Plans
By Jean D. Sifleet
John Wiley & Sons
Copyright © 2003
Jean D. Sifleet
All right reserved.
Running a business can be so all-consuming that it is easy to
lose sight of long-term goals. It is important to take time out
to regain perspective on what you are trying to accomplish:
Attract and retain key employees?
Plan for retirement income?
Employees are a key challenge for small business owners.
The success of the business depends on attracting and retaining
high-performing employees. Top performers want more
than basic salary, benefits, and vacation days. Motivating key
employees requires recognition and rewards. If used effectively,
incentive compensation can be a powerful tool to reward
Reducing taxes is always attractive to business owners, as is
planning for retirement. After achieving profitability, smart
business owners start to think about deferring current income
and putting money into retirement plans. The tax advantages
are clear: You can reduce currenttax liability, both personally
and for the business, while allowing invested assets to grow tax-deferred.
Although many business owners and their employees
are concerned about deferring current income and planning for
their retirement, the reality is that a plan is seldom in place.
Many of the 26 million small businesses in the United States,
which employ 51 percent of this nation's workers, have a compelling
need for retirement planning.
DIFFERENT GOALS NEED DIFFERENT PLANS
Since personal and business goals should drive the planning
process, this chapter includes checklists and forms to assist
you in prioritizing goals. As you read, ask yourself, "What is
really important to me down the road?"
1. Comfortable retirement?
2. Do not want to pay for employees' retirement (maximize
3. Reduce taxes?
4. Share profits with employees without sharing ownership?
5. Encourage employee ownership?
6. Personal goals ___________ (insert your personal goals)?
COMPENSATION AND BENEFITS EVOLVE
AS THE BUSINESS GROWS
Compensation and benefits often develop on an as needed
basis to fill specific requirements during the development of a
business. Many companies start with basic pay and benefits,
and then add other benefits as the business becomes able to afford
the expense (see Table 1.1).
Small businesses have to be creative with compensation
since few of them can match the pay and benefits offered by
larger companies (see Table 1.2).
Flexibility and the opportunity to share in future growth are
major attractions for employees of small businesses. Providing
employees with incentive compensation that matches the goals
of the business (and business owner) is critical.
"BE CAREFUL WHAT YOU ASK FOR"
There is an old saying: "Be careful what you ask for-because
you may get it." Employees respond to incentives, so it is important
to align your incentives with the company goals. If the
two do not match, you will not get the desired results. Poorly
designed incentive compensation can backfire and be counterproductive,
whereas rewarding excellent performance with
well-designed incentive compensation can create a prosperous
business environment (see Table 1.3).
FOR A CURRENT TAX DEDUCTION,
YOU NEED A "QUALIFIED PLAN"
To get a tax deduction for contributing funds to a "qualified
plan," you must comply with strict rules for including employees
and limiting contributions. Examples of qualified plans include
401(k), SEP (Simplified Employee Pensions), SIMPLE
(Savings Incentive Match Plans for Employees), and ESOP (Employee
Stock Ownership Plans). In addition, there are investment
options and differences between defined-benefit (DB) and
defined-contribution (DC) plans (see Table 1.4).
TO LIMIT PARTICIPATION IN THE PLAN,
YOU NEED A "NONQUALIFIED PLAN"
Nonqualified plans allow you to limit the participants in the
plan. This means that you can exclude some employees and
only include the principals or selected members of your team.
Although you will not get a current tax deduction for your
contributions, you can achieve aggressive financial benefits
with nonqualified plans.
With these plans, there is no tax deduction until the employee
begins receiving benefits (usually at retirement). When
the employee begins reporting income, the employer can deduct
the payment. Examples of nonqualified plans include Supplemental
Executive Retirement Plans (SERP), excess benefit plans,
and split dollar plans (see Table 1.5).
Nonqualified plans that enhance retirement benefits can be
powerful tools to attract and retain key employees. "Forfeiture"
provisions (also called "golden handcuffs") encourage
employees to stay with their present employer instead of leaving
to work for a competitor.
LOOK AT THE BIG PICTURE BEFORE
DIVING INTO THE SPECIFICS
It is important to step back and reassess what you are trying to
accomplish before focusing on specifics. Incentives, deferred
compensation, and retirement planning are components of the
overall compensation plan for the company. Since compensation
drives business performance, you need to align your compensation
strategies with your business goals.
THE BEWILDERING ARRAY OF ALTERNATIVES
Evaluating the alternatives can be overwhelming for small
business owners who focus primarily on running the business.
Examining the options can be like getting lost in the "trees"
(details and issues) and losing sight of the "forest" (the business
goals). Large corporations hire compensation experts to
perform analyses, design models, and create complex, multifaceted
compensation programs. Most small business owners,
however, have neither the time nor personnel for such elaborate
In choosing a plan for your business, cost and complexity of
administration are major factors. So it makes sense to focus on
that perspective when looking at your options. As we discuss
the alternatives, we will view them from the perspective of
easy and inexpensive to administer, to more complicated and
costly, to complex and expensive. This framework will help
you evaluate the pros and cons and make a choice that is a
good fit for your business (see Table 1.6).
If you already have a plan in place, changing is tricky. You
must carefully plan any changes and clearly communicate them
to motivate employee performance and achieve business results.
Changes are disruptive and raise concerns with employees.
To ensure a positive outcome, think about compensation in
a comprehensive manner. Do not just add a 401(k) plan without
looking at the overall picture.
So, step back and reassess what you are trying to accomplish
before tackling the specifics of the options. Filling out Worksheet
1.1 will pinpoint your long-term objectives and enable
you to make informed choices about the options available.
Different situations require different plans. Writing down
this information will make it easier to pull together a request
for proposals later. It will also help you avoid the following
COMMON MISTAKES IN RETIREMENT PLANS
Cynthia Sechrest, CPA, co-owner of Sechrest Financial
Services, LLC, a fee-only financial planning firm located
in Acton, Massachusetts, and on the Internet at
sechrestfinancialservices.com, shares her insights and
In her tax practice, Cindy met many small business owners
with successful businesses but a short-term financial perspective.
Cindy saw a need to help her clients with long-range financial
planning for small business owners and individuals.
In working with her clients, Cindy sees some recurring
1. Not taking the time to think about retirement planning
Business owners just do not take the time to think about retirement
planning. "Turning 50" is a triggering event for many
people to get serious about retirement planning.
2. Picking a plan that is too complicated for their business
It is quite common for a business owner to implement a
401(k) plan that sounds great. In reality, for a business with 10
or fewer employees, the cost can be prohibitive and the complexity
3. Underestimating the amount of time needed to educate
employees about the plan
Communicating with employees about the plan takes a lot of
time. It is not uncommon for an employer to put a plan in place
that achieves only low employee participation. This causes the
plan to fail the "nondiscrimination" tests and triggers a big administrative
hassle. If employees are not English-speaking, the
complexity of communication is significantly greater.
4. Not understanding how the plan is funded
In looking closely into some plans, Cindy found that they
were funded with life insurance or variable annuity contracts.
These business owners thought they were dealing with a "pension
consultant," but in reality they were dealing with a life
insurance salesperson. If the person's business card says "securities
offers through ..." or "registered with ..." you are
talking with someone who is selling products, not just offering
advice about retirement plans.
Life Insurance Is Not Appropriate for Funding
Cindy feels strongly that although life insurance is an important
part of personal financial plans, it may not be appropriate
for retirement plans.
A business owner should ask these key questions:
"Am I locked in?"
"Are there surrender charges?"
"Can I change my investments?"
In conclusion, Cindy encourages business owners to carefully
assess what is necessary to successfully implement the
retirement plan before jumping in.
Excerpted from Beyond 401(k)s for Small Business Owners
by Jean D. Sifleet
Copyright © 2003 by Jean D. Sifleet .
Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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