In the market

Entrepreneur, March, 1998 by Joan Szabo

There's never been a better time to establish a tax-favored pension plan. The benefits are double-barreled for entrepreneurs. Setting up a qualified plan not only provides you with a tax deduction for the contributions you make on your employees' behalf, but the money you contribute to your own account is also deductible and is not included in your taxable income until withdrawn. (A qualified plan meets the requirements of the Employee Retirement Income Security Act and the IRS Code.)

On top of that, your own contributions to your account are allowed to earn interest that's tax-deferred until you make a withdrawal. "The power of compounding with pre-tax money is very powerful," says Ward Bukofsky, a CPA with Beverly Hills, California, accounting firm Braverman, Codron & Co.

Accountant Mark Cohen, a CPA with New York City accounting firm Newman & Cohen CPA PC, agrees. "We have some clients with several million dollars in their retirement plans thanks to regular retirement contributions and related tax deferral compounding."

Amassing this type of nest egg offers small-business owners a sense of security. "All businesses have ups and downs - and some don't make it," says Joan Vines, a CPA with accounting firm Grant Thornton LLP in Washington, DC. By setting money aside in a qualified pension plan, it is safe from creditors' reach in the event your company runs into financial trouble. As a result, Vines says, "that money is going to be there even if the business is not."

The Taxpayer Relief Act of 1997 also makes it easier to set aside funds for retirement in both a company retirement plan, such as a 401(k), and an Individual Retirement Account (IRA). That's because the new law increases the income limits on deductible IRAs in stages for individuals who are active participants in a pension plan. This year, you can fully deduct a yearly IRA contribution of $2,000 if your adjusted gross income is $50,000 or less for joint filers and $30,000 or less for single filers.

Another important change: The new law permanently repeals the 15 percent excise tax on distributions from retirement plans (including both IRAs and qualified plans) that

WHAT'S THE PLAN?

Despite these benefits, small-business owners often struggle over whether to use profits to grow a business or administer a retirement plan. But there doesn't have to be a choice. For example, with the use of a new, low-cost Savings Incentive Match Plan for Employees (SIMPLE), designed especially for small business, expenses can be held to a minimum.

If you've put off establishing a plan because of cost or complexity, now is a good time to examine the options available to you. "The sooner you start, the sooner you'll reap the benefits of a retirement plan," says Cohen.

Here's a brief rundown of the pros and cons of the major retirement plans:

* SIMPLE: This is one of the newest plans and one of the most attractive options available to small-business owners with 100 or fewer employees. With a SIMPLE plan, you can decide whether to use a 401(k) or an IRA as your retirement plan.

A SIMPLE plan is just that - simple to administer. It doesn't come with a lot of paperwork or reporting requirements. If you establish one, you must provide a single report to the government only when the plan is created.

Unlike a regular 401 (k), making contributions is not optional with a SIMPLE plan. The employer must make contributions to the plan by either matching each participating employee's contribution dollar for dollar, up to 3 percent of the employee's pay, or by making an across-the-board 2 percent contribution for all employees, even if they don't participate in the plan. This can be expensive.

"[Another] trade-off for being simple is that the maximum amount each employee can contribute to the plan is only $6,000 a year," says Vines.

Tax consequences: The maximum contribution amount is one of the lowest of all available plans. Therefore, the tax deduction for the contribution will not be as great as it could be with some of the other plans.

* Simplified Employee Pension (SEP): With this plan, you decide how much to contribute each year on behalf of each employee, or whether to contribute at all in a given year. Employees, however, cannot contribute any of their salary to their own accounts. In addition, if you decide to make a contribution, the same percentage must be applied to all eligible employees. The maximum contribution is 15 percent of an employee's salary or $24,000, whichever is less.

Tax consequences: The amount of the tax deduction for annual contributions to SEP accounts ranks just under a money-purchase plan or a profit-sharing plan.

* 401 (k) plans: Participants in a 401(k) have a percentage of pre-tax pay deducted from their paycheck and put into an account. The funds grow tax-deferred until they're withdrawn. One of the major benefits of a 401(k) plan for small-business owners is that you can establish the plan, but you aren't required to make contributions on your employees' behalf.