The three main objectives of investing are: to minimize the effects of inflation; to achieve financial goals, such as a home purchase or higher education tuition; and to enjoy your retirement years.
Regardless of why you invest, it’s smart to start saving ASAP. The younger you are when you start saving, the more money you’ll have when you need it later in life. And when retirement is on the horizon, the benefits of long-term investing become even more apparent.
Savings Strategies Before Retirement
Anyone, business owners included, can accumulate retirement funds through:
- Savings accounts and money markets. Financial planners suggest accruing at least six months of living expenses for emergencies such as illness or business problems. Interest earnings aren’t high, but savings accounts are the safest investment. They’re insured by the FDIC so there’s no risk of losing money in a savings account at an FDIC-certified bank.
- Certificates of Deposit (CDs). Offered through banks and savings and loan companies, CDs are short- or medium-term, interest-bearing, low risk FDIC-insured investments. Also known as time deposits, cash must stay in these accounts for a specified time period, typically from three months to six years. Short- and long-term CDs provide some flexibility for emergency withdrawals (with penalty fees), but essentially CDs tie up funds for designated periods of time and may not be available when needed.
Consider “laddering” CDs. Invest in a three-month, six-month and one-year CD. That way, you earn more interest and emergency money is more readily available.
- Bonds. Fixed-interest debt securities of more than a one-year period issued by governments, banks, companies, public utilities and other large entities that have an obligation to pay back the principle, with interest, at maturity or at designated intervals.
Bonds fall into different categories based on the bond issuer’s tax status, credit quality, issuer type, maturity and secured or unsecured standing. Fixed-rate bonds are subject to interest rate risk when prevailing rates rise. U.S. Treasury bonds typically are deemed the safest unsecured bonds, since the possibility of this federal agency defaulting on payments is highly unlikely.
- Stocks. An instrument that represents an ownership position (equity) in a corporation and a proportional share of its assets and profits. Risk and rewards go hand in hand. Generally, the higher the risk, the higher the potential reward. Persons nearing retirement should avoid speculation in stock markets, according to most financial consultants, because declining stocks often require sufficient time to rebound.
Retirement Plans for Small Business
Business owners put various retirement plans in place, both for themselves and their employees. Besides providing a valuable benefit to personnel, entrepreneurs enjoy tax savings in the process. The following is a list of the most popular retirement plans:
- Payroll Deduction Individual Retirement Account (IRA). A tax-deferred investment that’s easy to set up and maintain. Eligible to any business with one or more employees, workers’ contributions are made through payroll deductions so vesting is immediate. In 2008, the maximum, annual IRA contribution was set at $5,000, but persons over age 50 can invest more. Business owners should make IRAs available to all company personnel.
- Simplified Employee Pension (SEP). Easy to implement. Easy to maintain. SEP plans are available for any business that lacks another retirement plan. Employers start the process by completing IRS Form 5305-SEP, with no employer tax filing required.
These plans allow individuals to contribute and deduct up to 20% of self- employment income (25% of salary when the owner is also a company employee). Because the percentage can be changed annually - lower contributions or none at all - funding is flexible in lean years. Business owners planning to enroll in an SEP plan must offer this benefit to all company employees who are at least 21 years old and employed by the business for three of the last five years; vesting is immediate.
- Simple-IRA. This is a salary reduction plan with little administrative red tape. Any company with 100 or fewer employees, and with no other retirement plan, is eligible for enrollment.
To set up an account, complete IRS Form 5304-Simple or 5305-Simple. No employer tax filing is required, and the trustee financial institution does most of the paperwork.
Simple IRAs function through employee salary reduction contributions and/or employer contributions according to current IRS approved annual maximums. This benefit must be offered to all employees who have earned at least $5,000 in the previous two years and are expected to earn $5,000 in the current year; vesting is immediate.
- 401(k). Available to any business with one or more employees, these plans permit staff to contribute more money than many other investment options, with 100% vesting for employee contributions, and by “plan terms” for employer contributions. It’s a good idea for company owners to confer with a financial advisor when establishing a 401(k) plan because implementation requires filing IRS Form 5500, as well as annual non-discrimination testing to ensure the plan isn’t skewed in favor of highly-compensated employees.
A 401(k) account operates via employee salary reduction contributions and employer contributions in line with IRS approved maximum limits. A 401(k) must be offered to all personnel who worked at least 1,000 hours in previous years. Withdrawals are permitted for a specified event or as collateral for hardship loans.
- Safe Harbor 401(k) & Automatic Enrollment Safe Harbor 401(k). These plans allow employees to contribute more than other options without annual discrimination testing.
Eligible to any company with one or more employees, business owners should consult a financial planner regarding set-up. A minimum amount of employer contribution is required, along with annual filing of IRS Form 5500.
In addition, current maximum contributions for each plan should be reviewed annually. Eligible employees must have completed 1,000 hours of work in the previous year and be at least 21 years old. Safe Harbor plans mandate 100% vesting for employee contributions and by plan terms for employer contributions.
- Profit Sharing. Defined by its name, profit sharing permits employers to make large contributions for employees when business is going well.
An option for any company with one or more employees, owners should establish a plan through a financial advisor. A profit-sharing program requires annual filings of IRS Form 5500; employer contribution levels can be determined year to year as defined by current maximums.
Company owners may offer this benefit to employees who are at least 21 years old and who’ve worked at least 1,000 hours the previous year. Vesting periods follow the terms outlined in individual plans.
- Defined Benefit. These plans, available to any business with one or more employees, provide a fixed, pre-established benefit for enrollees. Besides requiring a financial planner to establish the plan and to annually file IRS Form 5500, an actuary must determine contribution obligations.
While funding typically comes from the employer, employee contributions may be allowable. Participating personnel must be at least 21 years of age and have worked 1,000 hours in the previous year. Payment of benefits usually occurs at retirement, with vesting over time according to plan terms.
The U.S. Department of Labor provides online compliance tools such as elaws advisors, interactive e-tools with information about employment questions, including compliance regulations and retirement security. Learn more about these topics at www.dol.gov/elaws/pwba/plans/final.asp