The Key to Business Owners Socking It Away
The Key to Business Owners Socking It Away

The Key to Business Owners Socking It Away



Michael R. McMorris
Michael R. McMorris

Retirement Plan Services Director
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The Key to Business Owners Socking It Away

How retirement plan design can help business owners catch up on retirement savings while maximizing tax deductibility and asset protection.

An interview with Retirement Plan Services Director Michael McMorris

Ten years ago, the Great Recession knocked out the American economy. Small businesses – led by gritty entrepreneurs – resuscitated it. From mid-2009 to 2013, small businesses accounted for 60 percent of the net new jobs.1

While small businesses pump life into the American economy, many small business owners aren’t pumping enough into their retirement accounts. Forty-seven percent of U.S. business owners state they have no retirement plan in place.2  However, an owner who is older than most employees can modify the company’s qualified plan to catch up in an efficient way through an age-based contribution allocation.

Here Michael McMorris, Retirement Plan Services Director at the Trust Company, shares how:

Why don’t business owners typically put away money for retirement?

Michael McMorris: Too often the urgent tasks of running the company preempt other important long-term plans. You see it often as owners get bogged down and don’t have time to deal with it. Some owners are overly optimistic, thinking that if they take care of the business it will take care of themselves in the future. These owners hope to sell the business and exit with a sufficient lump sum, so they believe that saving money for retirement isn’t necessary, which isn’t always how it works out.

Other owners only know about limited savings opportunities through basic retirement plans; they determine that the limited benefits are outweighed by the cost of maintaining the plan and funding for employees. In some cases, this may be true, but they haven’t seen advanced plan designs that are especially beneficial for successful, high-income owners. These optimized plans allow greater pre-tax savings for them without breaking the bank.

Skipping retirement plan savings means missing out on tax advantages, compounded investment gains, and – as many forget – a great Federal protection of hard-earned assets from bankruptcy claims or lawsuits.

What’s the difference between a basic retirement plan and one that is more advanced?

Most business owners think of a retirement plan as a 401(k) where an employee contributes, and sometimes the employer matches. That’s a basic plan. SIMPLE and SEP IRA programs are basic, too, and fairly limited. Many are unaware that a 401(k) is first and foremost a profit sharing plan, which gives owners more opportunities to defer income and allows some flexibility in contributing for employees. With profit sharing contributions, owners can currently invest up to $61,000 per year per owner.

The tax advantage of profit sharing contributions is the same as a 401(k) or matching contribution. But the trick is in how the profit sharing dollars are allocated among employees. An age-weighted allocation allows older owners to get a much higher rate of profit sharing contributions than the rest of the employees. In some cases, the owners keep more than 80% or 90% of the company contributions.

Why haven’t business owners heard of this?

This isn’t a new concept. Profit sharing has been around decades longer than the 401(k), and thousands of employers have done it. But it’s fairly unknown. Big companies don’t have owners looking to defer more income from the business, and they have too many employees to cover. Many small businesses simply aren’t profitable, so profit sharing is rare among those employers. This is a strategy for business owners whose income is great and need to defer more of it to reduce taxes and save a lot for retirement.

This is a strategy for business owners whose income is great and need to defer more of it to reduce taxes and save a lot for retirement.– Michael McMorris

What size of a company or income level is necessary?

A business with less than ten employees per owner is ideal, though it can work if there are more. Most employees should be younger than the owner, and an average age difference of at least eight years is best. The higher the owner’s taxable income, the greater the need for tax deferral. It really depends on if the owner can pay the bills while deferring an extra $30,000 - $40,000.

For owners with exceptionally high income who can afford to defer much more, a Cash Balance Defined Benefit (CBDB) plan can allow deferrals of as much as $200,000 or $300,000 annually per owner.

Can you give an example?

Yes, I’ll give you two.

Kim is a 55-year-old business woman who is putting $24,500 into her 401(k) a year and receiving a matching contribution of 4% of compensation. Her salary is $200,000, so her match is $8,000. That’s $32,500 in contributions, which isn’t terrible. All five of her eligible employees contribute at least 4%. With total compensation of $300,000, their match is a total of $12,000. There is no vesting schedule, and Kim keeps only 40% of the employer contribution.

If Kim makes a 5% profit sharing contribution for the employees, then Kim will increase her total contributions from $32,000 to $61,000 (because most of her employees are sufficiently younger). This is possible with an age-weighted profit sharing allocation of 18.25% of her pay with employees getting just the 5% of pay. That’s an additional $29,000 tax deduction that Kim can keep. The employees will get a total of $15,000. Kim will keep 71% of the employer contribution. Kim can also have a vesting schedule on a portion of the contribution for employees.

The other example?

John was a successful doctor in his 40s, building his fourth office and a vacation home. His habit was to invest in his practice and spend most of his income of more than $1 million a year. He worried he wasn’t putting enough away for retirement. In fact, he hadn’t saved much at all. He also had big tax bills and was concerned about asset protection.

Most of John’s employees were in their 30s. Only two employees, including his wife who was the office manager, were older than he was. With an age-weighted profit sharing allocation, and also a CBDB plan, John and his wife were able to defer close to $400,000 annually into the plans on a pre-tax basis for about ten years. The compounded growth on the roughly $160,000 in annual savings that would have gone to Uncle Sam and the state far outweighed the $30,000 cost of contributions for employees.

The best part was that his savings were protected under ERISA from creditors and malpractice claims.

Any additional benefits of advanced retirement plans?

As a rule of thumb, in order for an owner to maximize savings, the company has to put in a minimum amount for employees. It’s usually 4-5 percent of compensation for profit sharing plans and an additional 3-4 percent when a CBDB plan is added.

For some employees, this may be a life saver. Many are not saving enough and some not at all. Employers who commit to providing at least some of their employees’ retirement savings are doing good for the people they care about, for those who contribute to the business every day. I’ve seen the difference this can make, especially with employees who have realized that without those employer contributions over many years there would be no way to make ends meet in retirement.

There’s a glaring trend of retirees needing financial help: A study from the Consumer Bankruptcy Project shows that the percent of bankrupt filers age 65-74 has increased from 2.1 percent of the bankrupt population in 1991 to 12.2 percent in 2016. Between 1992 and 2016, the percent of senior households with debt increased from 41.5 percent to 60 percent.

Not only do company contributions help solve this but they are efficient. Contributions are tax deductible expenses and are not subject to payroll taxes as are cash bonuses. Employees don’t pay income taxes until the money is withdrawn in retirement after presumably growing from investment gains.

A nice feature of profit sharing is that employers don’t have to give the same rate to all employees. They can also require that employees be employed through the last day of the year and work at least 1000 hours in the year to share in the annual profit sharing contribution. And the contributions can be subjected to a vesting schedule.

Can you give an example of different rates for different employees?

Say a law firm wants to maximize profit sharing so that the equity partners can invest and get their maximum tax benefits and asset protection benefits. They are able to do that as long as the rank and file employees receive a certain minimum, which may be 4.4% of gross pay. But maybe they want to reward certain employees with more than the minimum. Maybe the minimum for newer clerical staff, 6% for senior staff, 7% for paralegals and associates, and 5% for others. They could give less than the minimum to or even exclude non-equity partners who are highly compensated employees, which means they made more than $120,000 last year.

How does a vesting schedule work?

A six-year vesting schedule means you need to work for the company for at least six years to be able to take 100% of the employer contributions and earnings on those dollars with you when you go. Say an employee leaves after three years and is 40% vested. If the company had put in profit sharing of $5000 and it grew to $7000, the employee can only take $2800. The remaining $4200 stays in the plan and can be used for future profit sharing for other employees or to pay administrative expenses.

Isn’t it expensive to sponsor a plan for employees?

There are administrative fees and funding costs. But generally they are an investment with a proven ROI (return on investment). The more optimal the plan design, the more the benefits of the plan outweigh the administrative expenses. Plan sponsors need to consider whether the point of the plan is to simply provide a savings opportunity for employees, be a meaningful financial benefit for employees, or be a powerful financial tool for owners. We help clients with this cost benefit analysis.

A qualified plan can more than pay for itself especially when there are meaningful benefits for owners and/or for employees.

How so?

If a company simply pays a cash bonus, that conveys appreciation and rewards a job well done. But it is subject to the employee’s income tax rate and is also subject to payroll taxes by the employee and employer for social security, Medicare and unemployment insurance. Cash bonuses tend to give employees more mobility to look for different employment, too. And once the employee has received that money, it’s gone.

Unlike cash bonuses, profit sharing contributions are not subject to payroll taxes, which can equate to thousands of dollars of savings for the company. Profit sharing gives owners more control of the incentive over a period of time through a vesting schedule. For decades to come, those contributions continue to help employees who otherwise wouldn’t save and invest as much on their own.

I think most owners have an ‘aha’ moment when they realize that profit sharing contributions reward employees for contributing to the business, whereas matching contributions reward employees for contributing to the 401(k) plan.– Michael McMorris

Does this attract employees?

A regular profit sharing contribution will attract employees who are interested in the company’s future because the company is investing in their future.

How do you help business owners overcome their reluctance to embrace a profit sharing plan?

You show them the numbers that can address their point of pain. Maybe it’s the high taxes an owner is paying on a growing income, and they are looking for deductions. Maybe they need to see that they will not have enough to retire unless they start investing more. Sometimes the asset protection is important. And they like the ability to give different amounts to different employees.

I think most owners have an ‘aha’ moment when they realize that profit sharing contributions reward employees for contributing to the business, whereas matching contributions reward employees for contributing to the 401(k) plan.

1  The US Small Business Administration,

2 TD Bank,


Tags:  401(k), Americans and Retirement Savings, Cash Balance Defined Benefits, Employee Profit Sharing, Optimizing Retirement, Profit Sharing, Retirement Plan Design, Retirement Savings, Retirement Savings for Business Owners, Retirement Savings in America, Small Business Owners Retirement Savings

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