6 Small Business Retirement Plans

How to save for retirement if you’re a small business owner, or if you work for one. How to calculate your “power percentage.” And do you say nitch, or niche? This is Your Money, Your Wealth.

Today on Your Money Your Wealth, six small business retirement plans from easy to complicated, determining your retirement readiness by calculating your “power percentage” and Joe and Al explain how buying expensive cologne online relates to behavioral finance. Now here are two guys who have really found their niche – is it it nitch? Anyway, Joe Anderson CFP and Big Al Clopine, CPA.

:32 – Anchoring and Behavioral Finance

JA: Yes we are back for another episode of Your Money Your Wealth. Thanks for tuning in. Got a show lined up for you today.

AC: Not a good one, just a show. I like it. That’s honest. That is a fair and balanced reporting. (laughs)

JA: It is. it is. It’s hard to come by. (laughs) You know, I watched a really uplifting movie the other day.

AC: Yeah, which one?

JA: Manchester By The Sea.

AC: Oh boy, I didn’t want to see that one. (laughs)

JA: Oh man, you wanna have a barrel of laughs!

AC: I have a friend, a church friend, that went to that and left halfway through. It was too depressing.

JA: It just didn’t get any happier.

AC: Yeah you just kept thinking there’s got to be something. (laughs)

JA: Can I feel like an ounce of happiness! Jeez! (laughs)

AC: Yeah, I love movies, go fairly often, but I gotta look at the happiness quotient. I don’t like to pay 20 bucks and get all depressed. I want to see it Lion, you know, uplifting. And Hidden Figures and LaLa Land, and that’s what I want. (laughs)

JA: LaLa Land, I still haven’t seen that.

AC: That’s pretty good. You would like it I think.

JA: Yeah, I like music.

AC: Yep. I don’t usually like musical type movies, but I really like that one.

JA: Well I guess that that’ll be on the list. You know, I watch a movie, I don’t know, once every six months.

AC: Well, you watch them when they come out…

JA: on TBS. (laughs)

AC: Yep, I was gonna say DVR but you don’t have a DVR.

JA: Yeah I don’t even have that.

AC: Do you do Pay Per View at home? Do you even do that?

JA: Yes, that’s what I did, I was with my mother. She wanted to watch it on Saturday night.

AC: So that’s why. I know you didn’t have a VCR, and then now you don’t have a DVR.

JA: Nope, no DVR. Yeah I got just basic cable.

AC: You got a TV with cable.

JA: Basic. Yeah I got like eight channels. That’s all I need.

AC: That’s it. (laughs)

JA: I want to get into a few different things today. You know the markets are pretty excited, to say the least.

AC: They seem to be, don’t they?

JA: Yeah. And I think there’s some concern there, which I don’t think there should be a lot of concern, but anytime markets go really high or really low, there’s always this level of anxiety.

AC: In either direction. How high can it go? It’s too high. Or it’s low, everyone’s thinking it’s going to go lower.

JA: Right. I think it’s always boiled down to this behavioral finance term called anchoring. And I think I talked a little bit about this before. People anchor a certain number, you know what I mean? And a simple example is that if you buy stock at $50/share. And if it goes down to $30/share, people will not necessarily want to sell that particular security until it gets back to $50/share. No matter what the fundamentals are, or anything else. It’s just an anchor. It’s $50, I’m not going to sell it until I get my money back. But then on the opposite spectrum, if it goes to $100/share, they’ll be like wow, this is great. But I think this might now be overpriced because they’re up 50. And they’re using their particular share price of when they purchased it. And so I think we might anchor a little bit on what we hear in the media when it comes to the Dow Jones. The Dow Jones by the way is only 30 stocks. It’s not a great representation of the overall market but that’s all we hear. The Dow Jones is up 400 points, 300 points.

AC: How did that happen? I mean the S&P 500 is 500 companies but the Dow Jones is only 30.

JA: They’re the 30 largest. So I mean if you take a look at market capitalization, I think it’s an OK representation, but it’s not the best representation.

AC: It’s not the broad market.

JA: Right, it’s not the broad market. And the S&P 500, still – you want to look at the Wilshire 5000.

AC: So that’s 5000 companies. That’s more of the market.

JA: Yes and then you have to take a look at how is the overall benchmark, and I don’t want to get too far in the weeds. I want to get to your great list. (laughs)

AC: I know you can’t wait. (laughs)

JA: Yes. But when you look at, the Dow Jones is now 21,000. The market was up 300 points. Oh, the Trump rally and everything else should I get in, should I get out? What’s going to happen with interest rates? This is just noise in the short term. Your money needs to last you for the next 20, 30, 40, 50 years. So all of this is going to be a blip in the overall grand scheme of things. If you ever looked at the chart of the markets, and if you bring up that chart long enough, even 2008 doesn’t even look like a big dip. And that was one of the worst markets we’ve ever experienced. If you bring that market out long enough, if you look from 1927, you can’t even see it. 1927 to today is like, “well, where is 2008?” It just seems like a straight line going up.

AC: But, there were a couple of years there where it didn’t feel like it.

JA: Yes absolutely. And so I want to make sure that everyone is aware that, yes, we are at all time highs, but I think you have to put things in perspective of what your goals are and what the money’s for. The markets will turn. They will go down. But what are you going to do when they go down? Are you going to freak out and go into cash? Are you going to stay your course? Are you going to rebalance? Are you going to tax manage? So that’s the true impact, I think, of people’s success or failure. But the media is so large when it comes to what they want to put out there. And I think it’s a huge disservice to the average investor, It really is.

AC: I think you’re right, and there is this tendency, Joe, to add to the market when it’s going up. Of course, the market works and there’s this tendency to take the money out or at least stop adding to it when the market’s down. I mean like 401(k)s for example, which is a really good example of dollar cost averaging where you’re buying a certain amount of shares each month, or each pay period, each time, sometimes the market’s high, sometimes it’s lower. Sometimes even like it when the market goes down because you’re getting more stock for the same amount of dollars, and so more opportunity. But what we see and even in 401(k) is people are adding a lot of money, or more money, as a general rule, when the market’s going up then when it goes down. How many times have you heard people say, “well I just stopped adding money to the 401(k) because it’s a bad time.”?

JA: Right, “I don’t want to put good money after bad.”

AC: Right, “Why would I put my money into this.”

JA: “Might as well throw my money into the fire.” You’re buying shares of companies, and those shares are going down in value at that present time. But you’re buying a lot more shares.

AC: Yeah, you’re buying it cheaper. It’s about the only time we run away from a sale and we buy it when it’s when the price is jacked up.

JA: Right. Our minds are not wired appropriately to invest. Because then you hear “I want to buy this particular stock because I feel it’s undervalued.” Well, if you actually have that information, that you truly think that you know more than the collective market, you’re either lying or you’re cheating or you know something that someone else doesn’t, and that potentially could be insider trading. So it’s like I’m going to buy this stock on sale because I feel that X Y Z is going to happen, and I think it’s underpriced and I’m going to make this huge profit. Well, if everyone else has that same information, I think the collective market does a decent job of pricing securities. It’s not perfect by any stretch of the imagination, but I think they do a decent job because of the billions of dollars that trade hands every single day. But in anything else in life besides stocks, you’re like, “hey I want to buy this stock because I think it’s significantly undervalued.” Well, you put another type of product – Alan I got a 7 Series BMW right outside in the parking lot here. 2017. It has a robot that drives it. You can have a couple of cold beers in the back seat, it’s totally legal. You could watch your La La Land movies. Y

AC: Where do I sign up?

JA: Right? And it’s beautiful, it’s black, it has all these computers in it, it can fly. I’ll sell it to you for 7500 bucks.

AC: Oh, sweet.

JA: So I mean, what’s the first thing that will come to your mind if that was actually the case?

AC: Well, you’d go, “there’s something wrong.”

JA: Something’s wrong with that car. Did you steal it? Are you BSing me? Things like that. But that’s underpriced. If you bought it at 7500 bucks, you would probably make a very good profit on that, if everything else was legit.

AC: Yeah. It’s the same kind of thinking, sometimes you go to a store or you look at a couple of articles of clothes, and you’re drawn to the more expensive one because you think this must be better quality.

JA: Oh my god, I just did that. It wasn’t clothes though. Never do this folks. I was running low on some cologne and the stuff that I usually have for years? I don’t think they make that stuff any more. I was the person to purchase that. So I’m like, damn it I can’t find this thing anywhere. So I go online. You should go to the store and smell the stuff. So I looked, it had a cool bottle, it was like 300 bucks. I thought this is gonna be great.

AC: So you just bought it?

JA: Oh my God. It was like repellent. It was so bad. It was like my eyes started to bleed when I put that stuff on. (laughs)

AC: Save it for summer and mosquitoes.

JA: Oh. My mother, she’s downstairs. I mean I have two story house. I’m upstairs in my bathroom, I put this on. She could smell it, like, outside. She was like, “oh my god, I thought a skunk came through this house.” So yeah don’t don’t purchase cologne on price tag, because I was like all this has got to be really good. (laughs)

10:31 – Big Al’s List: 6 Different Small Business Retirement Plans from Easy to Complicated

AC: If you’re a small business owner, this is really right on target, what you need to know. But even if you’re an employee, there are things that you can do personally, in certain cases, and then in other cases you may want to educate your employer, particularly if it’s a small business, on what plans are available. But Joe, the first one that I’ll mention right off the bat out of the six, is actually truly one that everyone can do, and that’s an IRA – an individual retirement account. And an Individual Retirement Account, as long as you have earned income and as long as you’re younger than 70 and a half, you can put in $5500, if you’re up to age 49. If you’re 50 and above, it’s $6500. An extra thousand dollars. And so let’s just say you’re single, and you don’t have a retirement plan. Let’s say you’re 30 years old, so you can put $5500 into your IRA, and you can take that as a tax deduction. So there is something you can do even if your employer doesn’t have a plan.

JA: And here’s another thing too. Let’s say if your employer does have a plan, a 401(k) plan that you’re fully contributing to. And then you’re thinking, hey I want to put a little bit more money in. You can still contribute to an IRA. You could double up. It’s not one or the other. So IRAs are great plans, you can do a traditional IRA or a Roth IRA, that might be on your list as well. But yes, $6500, you get the tax deduction if you want to put it in, grows 100% tax deferred. There are some income limits if you do have a qualified plan, but if you don’t have a plan at all, so let’s say the employer doesn’t have a plan you make $500,000, you can still contribute to the IRA and take the deduction if you choose to.

AC: You can. So here’s a few income limitations to be aware of. So this is, to start off, the person that already has a 401(k) plan. You can still do a deductible IRA. And if you’re single, as long as your adjusted gross income is less than $62,000 – there’s a phase out between $62,000 and $72,000. Then after that point, you can still make the IRA you just can’t take the tax deduction. And if you’re married, that phase out period is from $99,000 of adjusted gross income to $119,000. And I’ll tell you what, if you’re above those levels, or even if you’re below it, you might want to do a Roth contribution instead. You kind of have to think about this as either-or, or maybe both, but it’s the $5500 limit. In other words, if you do a $3000 regular traditional IRA, you could only do another $2500 in a Roth or vice versa.

JA: Right, good point because what’s funny about these whole stupid rules is that if I have a 401(k) plan, I can fully fund the 401(k) plan, and I can do a Roth IRA. But if I don’t have a 401(k), it’s either one or the other, or up to the maximum of $5500. It doesn’t make any sense at all.

AC: You have to have a chart to figure this out.

JA: Right, but then it’s like OK well here, do I do an IRA or a Roth IRA? Can’t I do both? Well sure you can do both, but only $5500 total. (laughs)

AC: I know right? (laughs) And then there’s this crazy rule that for Roth IRAs, if you’re single and you make more than $118,000, it starts phasing out your ability to do a Roth IRA contribution, and by the time you get to $133,000, you can’t do a Roth contribution anymore. And if you’re married, those limits are $186,000 to $196,000. So there’s these zones, I guess, of income, to where you can take a deductible IRA, in some cases you can’t take a deductible IRA, but you can do a Roth contribution. In other cases, you can’t do a Roth contribution because your income is too high, but you could potentially do a backdoor Roth. (laughs) Now we’re starting to get complicated, right? Whereas you actually put money into a traditional IRA, you don’t get a tax deduction. And this only works if you don’t already have IRA money, but then you can convert that money, and since you didn’t get a tax deduction, there’s no tax to pay on the Roth conversion. It’s a silly way to work around the contribution rules, but people are doing it all the time.

JA: But let’s say this Alan. Well the IRS is thinking, if you make too much money, we do not want you to do a direct Roth IRA contribution. Again a Roth IRA contribution is after tax. So you’ve already paid tax on it, and then you drop in$5500, or $6500 if you’re over 50. But wait a minute, you make too much money, we don’t want you to do it. But, however, there is no income limitations on doing a conversion. So let’s say if you take $5500 out of your already IRA or 401(k) that you’ve taken the deduction already, you could take the $5500 there and convert it, you pay the tax on the conversion, it’s basically the same-same. So there’s no income limitations on conversions. There are income limitations on contributions. So then it’s looking at, well what makes more sense, does the Roth make more sense, or does the traditional make more sense. And our answer is both. Always. You want to have diversification when it comes to how you’re saving. And don’t always look for the quick buck today. You might want to do after tax type contributions or conversions to get more money into a tax-free environment that you’ll never pay tax on again.

AC: Yeah I think that’s true and especially if you’ve got a 401(k) and then you might want to put enough money in there to get the employer match, and then you go back to the Roth and maybe do some Roth contributions. So you have some before tax, after tax, why that’s important is when you retire your 401(k) money or your traditional IRA money, you take money out of there you pay ordinary income taxes, but your Roth IRA, that all comes out tax-free. Even the income and growth, in addition to the contribution, it’s just a great deal for retirement, and it’s it’s a way for people to pay less taxes in retirement when they have that tax diversification.

JA: Yeah but conversions get a little bit more challenging, I think, when it comes to the psyche of the individual.

AC: OK what do you mean by that?

JA: As you have to pay the tax. If I did an after-tax contribution, it’s like no big deal because I’ve already paid the taxes, I don’t really feel it.

AC: Yeah, true, good point.

JA: And so this is where again the human mind and finances really don’t mesh well together, because it’s the same thing. I’d much rather do a contribution because then I don’t want to necessarily come out of pocket for taxes because the IRS already took that tax for me. I can’t do this on my own, I don’t have the discipline, so I let the IRS take it out for me first, and then I’ll do it. Versus saying no, I want to control it, let me do the conversion, then I can determine how much of that I want to go into a Roth, and determine how much tax I pay. But guess what. April 15th the following year, you’re going to have to cut a check to the IRS to pay the tax to get that money into the Roth. Sometimes people are like “well, I don’t know if I want to do this now.” Because it’s coming out of pocket versus already having it come out of pocket. It’s the same-same, but it’s just the mentality of you actually having to cut a check.

AC: It is Joe. And I want to review quickly the second kind of small business retirement plan, and that’s a SEP-IRA, simplified employee pension plan. This is a really common one for small businesses, because you can set it up after the fact. You can actually set it up in the following year for the prior year. So right now, you can still set up your SEP-IRA for 2016 even though it’s 2017 all the way to the due date of your tax return, which for an individual return would be April 15th, and you can extend that return to October 15. So you can actually set up a SEP-IRA to October 15th, if you have a small business that’s not incorporated. If you’re incorporated the due dates are generally March 15th and then six months extension after that is September 15th. Joe, that’s a 25% contribution amount for salary, if you’re incorporated it’s 20%. If you’re a small business owner that’s not incorporated, this is one that’s often missed, because people think, “well, I’m in a 401(k) with my employer, and I got this little side business, side hustle, and I’m not allowed to do a pension plan.” Yes you are, you can do a SEP. You can’t do a 401(k) all over again if you’ve already maxed out your company one, but you can do a SEP and you can actually put in, if it’s an unincorporated business, 20% of your profits up to a total of $54,000 in 2017. So if you make a lot of money in your side business, you could put a lot of money away.

JA: I mean it’s it’s really taking a look at the numbers to figure out what plan is appropriate for you. There’s a lot of different plans that you can take a look at. And I think that’s why it’s very important for you to understand, what are your options? And what makes more sense? Do you do pretax, do you do after tax? What’s the overall goals of the money?

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Yeah, today, Joe, we’re talking about the six different small business retirement plans, and the next one I want to talk about is a SIMPLE-IRA and that’s one that’s a little bit more sophisticated maybe than a SEP-IRA that’s kind of like an I don’t know if I want to kind like a poor man’s 401(k). I’ll just say it that way, how about that? (laughs)

JA: Wow, OK. Poor man. Check out the big wallet on Big Al! (laughs)

AC: It’s really easy to set up. You do have to set it up by October 1st of the year that you’re in. So it’s too late to do this for 2016, but you could do it still for 2017.

JA: So but it’s not too late because we’re in 2017, it’s March. So you can still do IRA contributions for 2016. You can still do a SEP contribution for 2016. But that’s basically it.

AC: Yeah that is about it. Some of these other plans you would have had to set up earlier. So now we’re sort of looking forward. In the case of a SIMPLE-IRA we’re talking 2017, and you set this thing up, it’s kind of like a 401(k) in that your employees can withhold a certain amount of their salary, and that amount is $12,500 that you can actually withhold from your pay. And so it goes into your own IRA, your own savings account, and you get to invest it how you want to. And then if you’re over 50, there’s a $3000 catch up. So that means $12,500 plus $3000, so it’s $15,500 that you can withhold. That’s not quite as high as a 401(k), a 401(k) is $18,000 versus $12,500, but it’s not bad. It’s better than an IRA, and your company needs to do a match, and there’s a couple of choices companies have. One is to do a 3% employees match. In other words, the employee puts in 3% of their salary, and the employer has to match that. And if the employee doesn’t put in anything, then the company doesn’t have to put in anything. That’s one way to do this. The other way is the company just elects to do a 2% max for everybody whether or not they actually make a contribution. I think in most cases we see employers doing the 3%, because they don’t necessarily have to do anything unless the employers do it. It kind of encourages them to make those contributions.

JA: Right. Let’s say if I’m a landscape architect and I have a bunch of employees that might be, I dunno, younger and are not looking at retirement, retirement savings. And so you’re thinking, “hey, I got five employees here. Maybe one of them might contribute to the plan. The other four won’t. So let’s just go 3% for anyone that contributes, because maybe the other four people won’t contribute at all. Because it’s money out of the employer’s pocket. They have to match whatever that other employee does up to that 3% level.

AC: That’s exactly right and that’s the reason why I like this better than a SEP-IRA. SEP-IRA you have to contribute the same amount to every employee. It’s an employer plan. So in other words, if you contribute 25% of your salary, you have to contribute 25% of everybody else’s salary. But in this case, you can put in $12,500 of your own money as a business owner, or $15,500 if you’re over 50, have a 3% match, so you get another 3% match, and all you have to pay for your employees is up to a 3% match, if they actually do it. And we know a lot of people and a lot of employees in Southern California, it’s a pretty high cost area. Not everyone has the wherewithal or they don’t think they have the wherewithal to contribute, and so they don’t.

JA: Right. So I guess if you put it in perspective, if you’re a small business owner, sole proprietor, you’re the only employee. You are also the employer. With the plans that we’ve discussed thus far, the SEP is probably your best choice, because you can maximize the most deferral.

AC: Yeah let’s say you make $100,000 for example, so you could then put 25– actually if you’re not incorporated, you put $20,000 roughly, if you do a SIMPLE it would be $12,500, $15,500 if you’re over 50, and then the 3% match would be another $3000. And that example would be relatively close. But as you make more money it’s a lot better to do the SEP, you can get a lot more in.

JA: Right, that brings up another good point too. It’s like, OK well what’s the forecast for the business? How much are you making now? How much do you project that you will make in the future? Then that’s going to determine what is probably the most appropriate plan for you.

AC: Yeah I think that’s exactly right.

JA: Because with the SIMPLE plan it’s it’s a straight contribution, it doesn’t necessarily have to do with profitability. So let’s say if you make $50,000, well 20% of 50 it might be less than $15,000. that’s $10,000 versus $15,000. So then you might go the SIMPLE route because you can shelter more money and it’s not based on a percentage of the profitability of the company. But if you have high profits, now you’ve got to switch back to the SEP plan. So it’s a little bit of homework for you, but I think it’s well worth the homework because it can save you significant money in taxes, and also really boost your retirement savings.

AC: I think so too. And Joe, the discussion that you just went through is something that small businesses routinely went through until about 7, 8, 9, 10 years ago, because what happened was a whole new kind of retirement came out which is called a Solo 401(k). This is for companies that don’t have any employees. So, Solo, it’s just you. Or it could be you and your spouse, that’s considered one because you’re one taxpayer. So a Solo 401(k) means you can set up a 401(k) for yourself, just like a regular 401(k). And you don’t have any employees, so now you can do $18,000 for yourself or if you’re over 50 you can do $24,000. Plus you can do a profit sharing match of up to 20% of the profits if you’re a sole proprietorship or 25% of your salary if you’re an S-Corp, something like that. Actually, if you don’t have any employees this usually is the best way to go and you don’t really have to set up a complicated plan. In fact, you can go to any discount brokerage T.D. Ameritrade, Schwab, Fidelity, they have prototype plans. They don’t cost anything and basically you’re just setting up an account. You’ve got to sign a couple of forms, but you set up this Solo 401(k) account and you can put a lot of money in.

JA: Right. There are small administration fees, but nothing like a third party administrator, where you’re spending thousands.

AC: You’re right, it’s not very much. And the reason is, there are no other participants. So the reason why traditional 401(k) plans are expensive for companies, is they don’t want all the benefits to go to the highly compensated. So there are these top heavy rules and you have to have an actuary calculate this. I don’t know if it sounds simple or not, but it’s not. It’s very complicated and they typically get paid a couple of thousand bucks, 3000 bucks a year to do these computations. With a Solo 401(k) you don’t have to do that.

JA: So to put it another way, let’s say I’m really highly compensated I’m the owner of the company and then I have a few different employees. I’m making $500,000 and my employees are making 50 grand. So it’s like OK well here I want to shelter the most I possibly can, but the IRS doesn’t really care for that. They want to have equality through the employees. So for the highly compensated, there are these rules. So you can’t fully fund it unless the other employees do. So there are actuarial tables to take a look at the census of your company to say here’s what you have to do, then that’s for safe harbor 401(k) plans come in, and everything else in between.

AC: You’re absolutely right. And I will say about the Solo 4-1(k) plan, and again, this is if you have a small business without employees, it could be a side business, that’s fine too. But you set up your own Solo 401(k)5. You’ve got to set that up by December 31st of the year that you’re in. That’s a little different than a regular 401(k) or a SIMPLE plan that requires it to be set up on October 1st. The reason why those other plans require October 1st is they want to allow your employees enough time to withhold from their pay to make it worthwhile. Solo 401(k), it’s only you and you can fund the entire contribution. Even your own employee part, the $18,000, in the following year, up to the due date of your tax return. And I don’t think that’s widely known. That’s April 15th if you’re a sole proprietor, or you can extend. I’ve seen some people fund their Solo 401(k) plans in October of the following year. And then they’ve got nine or 10 months of activity to figure out, “Can I really afford this or not?”

JA: You basically want to put the standard 401(k) contributions in in the calendar year, but then you have all sorts of time to look at what additional dollars that you want to put in. Depends on the business too, and what their cash flow looks like. But we always encourage individuals, especially sole practitioner where you might have volatile income, you got to pay yourself first. So you want to make sure that you get in the habit of putting that money into the 401(k) plan on a monthly basis to maximize that plan. And then when you do your taxes and kind of figure out exactly what the profitability is, then you can kind of monkey with the numbers to see what additional dollars that you can put in, like in a profit sharing type plan. So all sorts of different ways to slice this thing. You could really specifically design it for how your businesses is run.

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AC: So Joe, we’re talking about retirement plans for small business owners, and just to recap, there’s six of them that we’re reviewing. We talked about an IRA, we talked about a SEP-IRA, a SIMPLE-IRA, a Solo 401(k). Solo 401(k), by the way, is you’re a business owner, or even if you have a side business, you can set up your own 401(k) if you don’t have any employees. But what if you do have employees? Well, then you set up the next level, what you would call a safe harbor 401(k). And a safe harbor 401(k) allows you then, to offer a 401(k) to your employees. And it’s not as honorous, if that’s the right word, in terms of the actuarial calculation.

JA: Honorous? Onerous?

AC: Onerous. Onerous I think. OK. Anyway, it’s not as complicated! I’ll just say it that way.

JA: Do you say “nitch” or “niche?”

AC: “Nitch.”

JA: Yeah, I hate the “niche.” It just drives me nuts. Niche? What the hell’s a niche? Sounds like quiche!

AC: People that say “niche” talk about themselves in the third party I think. (laughs)

JA: “Joe has this niche.” Oh, I would have to slap myself in the face if I ever said that. (laughs)

AC: I actually did talked about myself in the third party last show.

JA: Third person?

AC: Third person. Yeah.

JA: You did?

AC: I said, “tell ’em Big Al sent ya.” (laughs)

JA: Oh my god that was somethin’ classic.

AC: (laughs) I knew I would get you. But we’re talking about safe harbor 401(k)s. And it’s the same rules as a regular 401(k) in that you can defer $18,000 of your salary, or if you’re 50 and older, you can do $24,000. And then there’s a match. And the way the match works is, either as an employer, you can elect to do a 4% match, meaning that if an employee puts in up to 4% of their salary, you have to match it. If they put in 1% of their salary, you have to do 1%. if they put in 3%, you do 3%. Up to 4%. They put in 10% of their salary you will you just do four. That’s where you cap out. So that’s one option. But that’s that’s only if they contribute. The other option is you do 3% to everybody, whether they contribute or not. Most companies elect the 4%, because a lot of employees don’t actually take advantage of the match. And so why put money in if your employee’s not contributing. So that’s a common way to go. You do have to set up these plans by October 1st. So it’s too late for 2016, but it’s not too late for 2017. There is, I will say, there are more administration fees on a safe harbor 401(k) as compared to a Solo 401(k). In other words, you do have to pay an actuary to do 5500s, which is the tax filing, they do certain calculations, it’s not as hard as like a regular 401(k). but you can probably anticipate- what would you say, $1500 at least, couple of thousand per year?

JA: Yeah, $2500 for a good firm, probably.

AC: Yeah per year. So these aren’t necessarily free. Most of the other plans that we’ve talked about are very inexpensive. So now we’re getting to a point where the plans are a little more expensive.

JA: Right, it gets more complex with more employees, more participants, there’s more regulatory kind of oversight, they want to make sure that these plans are set up appropriately, so it’s going to cost you a couple of bucks, and I think the downside of this, there’s cost of doing business everywhere you go. And so then you just have to look at the value of what you’re getting. Can I shelter some money in a 401(k) plan? I could go Roth, or I could go traditional. For $2500, and if you’re a small business owner that has multiple employees, I would imagine you can probably afford it. Don’t be so short-sighted. Your tax deduction alone on a couple bucks is going to pay for that, time and time again. The studies show this too, Alan. If I have a 401(k) plan and you don’t, and we have the same income. Same income, same lifestyle – 20 years later, who’s going to have more money saved, me or you?

AC: Yeah, the one with the 401(k).

JA: The one with the 401(k). I mean the numbers are staggering, of how much more that they have. And I think it’s unfair with all of these crazy plans and rules. They should just come up with one plan., $18,000, $24,000, you can either go Roth or traditional, for everyone. If you don’t want to participate, don’t; if you do, do.

AC: We should elect you so you can change these laws. (laughs)

JA: I’m going to go to Capitol Hill next week. (laughs)

AC: So I will say that, Joe, when you have a business, whether small business or otherwise, and you actually start making a whole bunch of profits, which by the way is the goal. When you have a business you want to make profits. (laughs) And the last kind of retirement plan I want to talk about is called a defined benefit plan. Defined benefit plan is completely different than every other plan that we just talked about because the amount that you can contribute is based upon a future desired benefit. It’s not based upon a contribution limit. And so interestingly enough like like right now, in 2017, they’ve got a formula that they use for these. And by the way, you have to set this up by December 31st of the year that you’re in. So it’s too late for 2016, but not too late for 2017. So here’s the formula you can use. You look at 100% of the participants average compensation for his or her highest three consecutive calendar years, or $215,000 if that’s lower. So $215,000 is the max for this computation.

JA: So that’s the maximum retirement benefit that I can produce.

AC: That’s the maximum compensation that can go into this formula. Now interestingly enough, if it’s a defined benefit… so let’s just say you want X number of dollars per month. I won’t use the numbers, but you want X number dollars per month, the maximum benefit allowed by law. Let’s say you’re 60 years old, and you’re going to have this defined benefit plan for five years, where you’re going to have to contribute a lot to get the maximum benefit. And we’ve seen 60-year-olds be able to put in $300,000 or more into their defined benefit plan. just to be able to get that benefit that they want. You know, there’s limits. You can’t do millions. There are upper limits. But unlike a 401(k) where you can put in, say you’re 60, you can do $24,000 plus profit sharing, defined benefit plan maybe $200,000 maybe $300,000. And by the way, that’s a tax deduction. If you’re in the highest tax bracket in California, with the federal tax, that’s about 50%. So $300,000 puts $150,000 in your pocket and you get the $300,000 working for you in your own retirement account.

JA: It’s huge. But now, that’s more complex. There’s a lot more work to that. But the benefits are gigantic if you have that type of profitability in your business. So it’s just looking at, again, what plan is appropriate for you? How do you set this thing up? And then can you piggyback on different plans? Maybe you want a 401(k) and a defined benefit plan. Maybe you have a 401(k) through your employer. Do you do a Roth IRA as well? Or do you have a side hustle? A lot of people are getting in the side hustle business. I’m going to start being an Uber driver on the weekends. (laughs)

AC: I’ll give you a good tip. (laughs)

JA: Yeah. So that’s a side hustle, that’s outside my business. I can set up, maybe, a SEP plan. All sorts of different combinations.

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36:19 – Calculate Your “Power Percentage” For Retirement Readiness

JA: Just got done with the list, Al. Great list this week buddy. It was just very riveting. Very exciting. (laughs)

AC: I had another one but it wasn’t as interesting. It was the 10 ways to prepare for retirement.

JA: Awful.

AC: And the first one was save. Second one was –

JA: Save more.

AC: – know how much you spend. Third one is contribute to your employer’s retirement. You know, it’s like obvious stuff although maybe it bears repeating sometimes. But, Joe, this is new information here, this is kind of interesting. Another way to measure your retirement readiness: your power percentage. (laughs) I kind of like this it’s a new way of computing your readiness for retirement.

JA: Alright, let’s see if I’m ready.

AC: Doesn’t matter what age… Well, I suppose it does matter a little bit. (laughs)

JA: Gotta read the article first. (laughs)

AC: If you’re 65 and haven’t done anything. I’m not sure this will save you with one year, but it can give you a sense of “Am I contributing enough to everything” and so here’s the formula. This will sound sort of complicated so I’ll summarize this but just bear with me for a second. So basically, add up all your savings, per month, but savings is defined as retirement plan deposits, employer match, college fund deposits, saving deposits, and then mortgage principal payments because you’re paying off debt.

JA: So I was going to ask you that, are they including paying off mortgage payments as savings.

AC: Yeah, they’re including mortgage debt, including credit card payments, if they’re cards that you’re not currently using. In other words, old debt that you’re paying down.

JA: Right, the cards that you pay off every month, that doesn’t count because that’s living expenses If you’ve accumulated some debt.

AC: You made some mistakes in the past, but now you’re cleaning that up.

JA: Really, so that’s a mistake if I bought like a fire pit or something on my credit card? (laughs)

AC: Big mistake. (laughs) And then let’s see, student loan payments above and beyond interest payments, a lot of stuff here. But essentially, it’s what you’re saving in your retirement plan, plus your employer match, plus any other savings you’re making. And your debt payments, your principal payments on your mortgage, paying your debt down. Maybe some old debt, student loan debt, or old credit card debt that you’re paying off. Not the new stuff. So you add all this up. So let me give you an example. So let’s say there are a thousand bucks a month going into your retirement account. Now let’s say you’re paying down on your mortgage about $500 a month principal. You’re saving about $300. and you’re paying off about $200 of student loans, so add that up, that’s $2000. $2000 of various kinds of savings and debt reduction. And then you look at your income. In this example, I’ve got $7000 and this is your gross income before taxes. So that’s 2000 divided by 7000. That’s 29%. Let’s see how you did in my example. So the power percentage scale is as follows: If you’re less than 10% you’re in big trouble. (laughs) You’re way too dependent on your income. Relief is not on the horizon because you’re not doing anything about it. You’re consuming your entire income while not saving money and not paying debts. If your power percentage is between 11 and 20, you’re doing OK. But you got a long way to go prior to retirement. If you’re between 21 and 34 you’re living a healthy financial lifestyle, and finally, a power percentage of 35% or higher proves that you’re well on your way to mastering your financial life. That’s a good little quick check to see how you’re doing on retirement.

JA: So let’s say my mortgage payment is 2000 bucks a month. So I have to look at the actual statement to see which, is that interest versus principal?

AC: Yeah and you look at if you’re paying your property taxes, that doesn’t count, just your principal payments.

JA: So this is pretty cool. So I’m going to take a look at my 401(k) savings, my match, then I’m going to take a look at what I’m putting in mutual funds for my Roth IRA. (coughing)

AC: Yeah. You get pretty choked up! You never heard about the power percentage. (laughs)

JA: Yes. I just realized I’m not good. (laughs)

AC: You need to up that!

JA: All right, so you take out all your savings. That’s easy. I think a lot of people know what their saving. But that debt calculation could be a little bit more complex, but I think that motivates people. You have to figure this out. So what are you paying on your principal each month? Let’s say if you have credit card debt, what are you paying there? The credit card debt is a full payment to the credit card, not necessarily as interest?

AC: It’s the full payment on your old stuff. Actually, it could be principal. I don’t know, if you really want to make this clean. But just make it easy. And this is not your current credit cards, it’s the old stuff that now you’re paying off, you’re not adding to it.

JA: So then you take that number and you divide it into your gross income?

AC: Yep. Before any taxes come out. And then you figure out your power percentage, and below 10% is not good, 11% to 20 is OK but you’ve got some work to do. 21 to 34 you’re living a healthy financial lifestyle. And if you’re 35% or higher, you’re a master at this. You’re going to have more money than you know what to do with. I did my own, Joe.

JA: Are you a master at this? Of course you are, you got big bucks for Big Al.

AC: I’m not a master, but I’m healthy living. I’m 28%. So I got to boost that up a little bit. Spending too much on my ties and suits. (laughs) Vacations to Africa, kids cell phone bills, college. Oh boy.

JA: Couple things too, I want to talk about with debt. There are a couple of ways to kind of look at debt, to pay it off. And this is excluding your mortgage if you have a mortgage. Maybe you have some credit card debt, maybe you have a car loan, student loan, and things like that. So there are two different ways to approach this. One way is just to document everything that you have. Let’s say you have four different credit cards. And then you can either categorize the four credit cards by interest rate. So the highest interest rate to the lowest interest rate. And then you say I want to pay the highest interest rate off first, and then kind of go down the list from there. So I try to maximize the highest interest rate payment, and then just pay the minimum on the other three. I like another way a little bit better.

AC: Yeah, what you just described makes a lot of financial sense and this is what the accountants out there would do. But I think I think just emotionally there’s another way.

JA: Right. So what you want to do, flip it upside down. Look at the balance. So let’s say you have a balance of $500, the other balance is $2000, the other balance is $4000, and so on. So I look at the lowest balance first. I don’t care what the interest rate is. I want to clean this thing up, because now I feel a sense of accomplishment. So I’m going to pay that $500 out, boom that’s done. I’m over it. Let’s go on to the next one. Two thousand bucks. OK I’m going to work my way to get that $2000 done. Boom. On to the next one. I think that motivates people a little bit better to say OK here now I’m making progress in getting rid of some of this stuff versus God, I’m not getting anywhere.

AC: Because I’m paying up this high interest rate stuff, and it’s mostly going to interest.

JA: I’m not seeing any movement.

AC: And then after six months you go, this doesn’t work. And then you just stop it. I completely agree. And some financial planners call this kind of a snowball effect. which is, you have you have little victories and then you start getting the confidence and you keep rolling in.

JA: Right. And student loan, there’s a people with a ton of student loan right now, the Social Security Administration is deducting more money I think than ever before out of people’s Social Security paychecks Al! And it’s going to student loan debt! So it’s like OK well mom and dad said I’ll help you with the student loan debt, and I’m going to cosign on this thing, or whatever. And now I have this debt burden, and now my Social Security benefits are getting reduced to pay off that debt. So you’ve got to get your arms around this thing. And I think just by looking at it – and don’t be ashamed of it either. You don’t want to put your head in the sand and say, “I have this debt… ” It doesn’t matter. Everyone has it. You just have to look at what is the best way to approach it. Have a plan to accomplish it, and you’ll feel so much better as you keep chugging along. You know what I mean? It’s like if you go on a diet. And you never lose any weight, you’re not going to stick to that diet. But if you lose a couple of pounds, you get a little bit more motivated.

AC: Yeah, and you start paying more attention to it and you go, this really does work.

JA: As soon as you start seeing a little bit of results. It’s like hey wait a minute. Now I’m going to focus a little bit more. I’m not going to go to McDonald’s. I’m not going to have that cheat day, or two days, or three days, or whatever it is.

AC: I think that’s absolutely right and that gets into behavioral finance, and sometimes, and this is a great example of you do something that kind of convinces you that this is working, and your accountant friends are probably going to do it the other way. But they may give up, because they get overwhelmed. It’s like “this doesn’t work.”

JA: I mean if you look at it from a true dollars and cents. Sure. I mean you know you pay off the highest interest rate first, because that’s what’s costing you the most. You want to get rid of that. But if I lose motivation, if I don’t get anything done, I’m going to go in the hole a lot more than if I can get myself little victories.

AC: Yeah, we just find people give up on it and that’s the problem.

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So, to recap today’s show: SEP-IRA, SIMPLE-IRA, Solo 401(k), defined benefit plans and more – whether you’re a small business owner or just work for one, there are several different options for retirement savings plans. The important thing is to save! Calculating your “power percentage,” which is your monthly savings and old debt payments divided into your monthly income, can help you determine how financially ready you are to retire.

For more smart retirement advice, subscribe to the podcast at YourMoneyYourWealth.com, through your favorite podcatcher or on iTunes, where you can also check out our ratings and reviews. And remember, this show is about you! If there’s something you’d like to hear on Your Money Your Wealth, just email info@purefinancial.com

Listen next week for more Your Money Your Wealth, presented by Pure Financial Advisors, a registered investment advisor. This show does not intend to provide personalized investment advice through this broadcast and does not represent that the securities or services discussed are suitable for any investor. Investors are advised not to rely on any information contained in the broadcast in the process of making a full and informed investment decision.

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