Retirement strategy for small-business owners: Grab the tax break

If you started a business during the last few years, and then watched too much of your earnings evaporate at tax time, you might be able to change that.

If you aren't putting any money into a retirement savings plan for your business, you are probably giving more than is necessary to Uncle Sam and short-changing your future too. And that is easy to fix.

It might seem like a mistake to stash anything away for retirement now when your business is demanding so much cash and time. But because retirement savings plans give you a tax break upfront when you contribute money to them, you can often stretch your money further simply by using one of these plans.

"A retirement plan is critical," said Robert Keebler, a Green Bay, Wis., certified public accountant. "For every dollar you put away, you can save about 30 to 40 cents in taxes."

And once your money is in a retirement plan, Uncle Sam won't touch it until you retire and start pulling money out for living expenses after age 59 {. The money remains off-limits to taxes until retirement, a much better alternative than keeping it in a bank savings account, where interest is taxed annually.

If you are a sole proprietor with no employees, setting up a retirement plan is almost as easy as opening a savings account. So you don't have to worry about another headache added to the demands of the day. "You go to a broker like TD Ameritrade or a mutual fund company like Fidelity, tell them you want to set up an individual 401(k), and that's it," said Denise Appleby, chief executive of Appleby Retirement Consulting of Grayson, Ga. "It's simple."

The best plan for sheltering as much money as possible from taxes, she said, would be a solo 401(k). The amount you can save is based on a formula applied to your compensation.

For example, say you earn $100,000. Just like any 401(k), you will be able to contribute up to $17,000 as an employee in 2012. And anything you contribute will lower your taxable income. And, as a sole proprietor, you get an extra benefit. As the employer, you can also contribute about $18,000 through the company to your own 401(k), Appleby said. Your business then gets the benefit of reducing taxes by taking an $18,000 deduction.

So as you combine the $17,000 and $18,000, you come up with about a $35,000 contribution to yourretirement, and you get tax benefits on the entire amount. Try the calculator at http://www.tinyurl.com/smallbiz401k.

If you will be 50 years old this year, or already are, you can contribute another $5,500 on a pretax basis. So in total you can contribute as much as $40,500 to a solo 401(k) and get both individual and company tax benefits.

While this is done with ease, the process gets a little more complicated if your business gets to the point of hiring employees or if the money in the 401(k) exceeds $250,000, Appleby said. Then you need advice on proper record keeping and Form 5500, which must be filed to satisfy Internal Revenue Service and Labor Department requirements. The form is available at the Department of Labor website: http://www.dol.gov/ebsa/5500main.html.

Of course, by this stage of a business you should probably be turning to a certified public accountant for advice on structuring other aspects of your business from a tax standpoint.

You cannot wait until the last minute to set up a 401(k). It isn't like an IRA or Roth IRA that can be opened and funded on the last day of tax filing season in April. It's worth thinking in advance because you can only put $5,000 a year in an IRA or a Roth IRA; $6,000 if you are 50 or older.

If you forget to open a 401(k) and tax time creeps up on you, there's another option for retirement saving that will also allow you to get a tax deduction. It's a SEP IRA, a very easy retirement savings plan for a sole business owner. The trouble with it is that it doesn't allow you to save as much and shelter as much from taxes as a 401(k).

For example, the person who made $100,000 on a business this year would be able to put only about $18,000 into a SEP IRA, Appleby said. Another option, known as a SIMPLE IRA, is set up for small businesses, but with $100,000 from a business, the total contribution in a SIMPLE IRA could be only about $14,000. And this cannot be opened at the last minute at tax time either.