NEWSLETTERS

Don’t give up on your Retirement Plan

As the economy sours and investment gains become elusive, some business owners may conclude that it is time to abolish their retirement plan.   According to the Bureau of Economic Analysis, the U.S. saved $378.6 billion in December 2008, compared with $299.1 billion in November 2008.  Personal saving as a percentage of disposable personal income was 3.6 percent in December, compared with 2.8 percent in November.   In December and November 2007 the personal savings rates were less than 1 percent.  As personal savings rates increase, 401(k) retirement plans as a vehicle for those savings provide the added benefit of saving both federal and state taxes.  Which is why now is not the time to give up on your retirement plan. 

An employee that saves $5,000 in a 401(k) plan versus an after tax account can reduce their tax liability by the federal and state tax rate.  Assuming a combined tax rate of 20 percent, the employee saves $1,000 in taxes by contributing to the 401(k) plan versus an after tax account.

Current market performance in retirement plans, and all types of investments, is not creating any incentives for 401(k) plan participants to continue or increase their savings.  If employees are frustrated with losing principal, as an idea and not investment advice, a short term strategy might be for a participant to redirect their future contributions into the most conservative investment choice available in the plan such as a cash account, money market or short term conservative bond fund.  This can alleviate the thought process that contributing to the retirement plan is not advantageous.  Prior to any plan changes, the plan’s investment advisor should be contacted and all plan investment decisions should be discussed throughly.

At this time plan sponsors and investment advisors might consider confirming that the plan has a couple of conservative investment choices available in the plan that allow participants to retain their principal.  In most plans, fund changes can normally take place within a day or two.  Employee education is always important but it is especially paramount when the market deteriorates as it has since November 2007.  Contact the plan’s investment advisor and schedule an employee education meeting.

Now is a great time to review or create a long term savings and investment strategy.  Assume we have a 48-year-old business owner who would like to retire at 65 with $500,000 and a current retirement account balance of $100,000 and an annual salary of $100,000.  The company sponsors a safe harbor 401(k) plan in which the company contributes 3% of each employee’s salary.  This plan would allow the business owner the opportunity to save the maximum 401(k) amount of $16,500  for 2009. 

Assuming the 401(k) limit stays the same for the next 17 years, the total 401(k) contributions which this business owner can contribute would equal $280,500 with a tax savings of $56,100 assuming a 20% tax rate.  The business owner would also receive employer contributions of $3,000 per year or $51,000 over 17 years.  The total in 17 years would be $431,500.  Investment earnings of $68,500 or less than 1% per year are needed to reach the retirement goal of $500,000 at 65.

These simple facts remain: the IRS will probably increase taxes and the annual 401(k) dollar limit over time; this bear market will not last forever; at some point everyone will retire and money will be needed in retirement.  So as markets go up and markets go down, you are going to have to save for retirement. 

2009 can be thought of as “the year of responsibility.”  Individuals are responsible for their own health, success, preparing and paying their taxes, and saving for retirement.  Professionals can be retained to help in every area of one’s life, but the ultimate responsibility lies with the individual.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) which was signed into law on June 7, 2001 has a “sunset” provision which allows all of the tax cuts to expire at the end of 2010.  Regardless of whatever tax changes are signed into law in the coming years, the consensus is that taxes are going to increase.  From a tax planing standpoint, retirement plans provide the best place to save for retirement. 

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