Higher income

The retirement plan you have is probably not the one you need

You set something up years ago, when the business was smaller and the decision was mostly about getting a plan in place at all. The business changed. The plan did not.

Usually the conversation starts with a comment rather than a question. The owner mentions, in passing, that they put in the maximum again this year, and the maximum turns out to be a fraction of what the business could support. Nothing was done wrong. The plan was correct on the day it was chosen and nobody revisited it.

This is one of the few areas where the money left on the table is large, the fix is well defined, and the reason it has not been fixed is simply that the subject never came up again.

The misconception

That a retirement plan is a one-time decision. You pick one, you fund it, you move on. It feels like infrastructure, like choosing a bank, rather than something with an ongoing fit to a business that keeps changing shape.

It is closer to insurance cover. Correct for what you had at the time, and worth checking against what you have now.

How the options actually differ

The available plans differ enormously across three dimensions, and the differences are not marginal.

How much can go in. The gap between the smallest and largest options is not a matter of a few thousand. Some plans allow a modest annual amount. Others allow a contribution several times larger, and a further category allows more again where the facts support it.

Who else you have to include. This is the dimension owners underestimate most. Some plans require you to cover employees who meet service conditions, and to contribute for them at a level tied to what you contribute for yourself. A plan that is generous to the owner can be expensive to the business.

What it costs to run. Some plans are close to free to maintain. Others require annual testing, annual filings, and professional administration, with fees that recur whether or not the business had a good year.

The question is not whether your plan works. It is what is available, and whether you would choose the same one today.

A plan that fitted a sole operator rarely fits a business with staff. The inclusion rules change everything once there are employees who qualify. The reverse is also true, and it is the case people forget. An owner who once had a team and now works alone, or with a spouse, is frequently carrying a plan built for a payroll that no longer exists, complete with the administration cost that came with it.

The number

As a range, the difference between the lowest contribution option and the highest is commonly a multiple rather than a percentage, and for a high earning owner with no qualifying staff the spread can be very large. What it is for you depends on your income, your entity type, whether you take a salary or a distribution or both, your age, and how many employees meet the service conditions.

Contribution limits are set annually and adjusted. Any specific figure has a year attached to it, and last year's figure is the wrong one to plan against.

The tax effect follows the contribution, at your own combined rate, which means the same contribution is worth more to someone in a high year than to someone in an average one. That is also why the plan choice and the income projection belong in the same conversation rather than in two separate ones.

What this requires

• A census of who has to be covered, based on the actual service records rather than on who you think of as staff.
• An honest view of whether the contribution is sustainable across an ordinary year as well as a strong one.
• Entity and payroll facts, because how you pay yourself sets what the contribution can be based on.
• Filings and administration that may not have existed under your current arrangement, budgeted for before the plan is adopted.

The census is the step people want to skip and the one that decides the answer. Part time and seasonal workers are the usual surprise, because the rules look at hours and service periods rather than at how the business describes the role.

Who this is not for

Businesses with irregular income that cannot commit. If the revenue swings and a poor year is a real possibility, a plan that requires a contribution in every year is a liability rather than a benefit. Being unable to fund a commitment is a worse outcome than having chosen a smaller plan.

Owners with staff where the inclusion rules make the cost outweigh the benefit. Run the arithmetic before adopting anything. If covering the team costs more than the owner's own tax saving, and the team benefit is not something you were seeking for its own sake, the answer is a different plan or the one you already have.

It is also not for a business that has not yet solved cash flow. Locking money away is the wrong move where the alternative use of the same money is paying down expensive debt or funding the working capital the business runs on. Retirement funding is what you do with money you are confident you will not need.

When this happens

Most plans have to be established before a deadline that is not the filing date. This is the detail that costs people a year. They raise the subject with the return in front of them, discover that a larger option existed, and find that the window to have adopted it for that year has already passed.

Some arrangements can be adopted later than others, and some allow the contribution to be made after the year ends provided the plan itself existed in time. The distinction between adopting and funding is worth understanding, and the rules on both move.

The point

Compare what is available rather than defaulting to what you already have. The review is short, it happens once, and it is the difference between a contribution that matches the business you run now and one that matches the business you ran then.

This is planning work. Your Charter team looks at it during the year, alongside the income projection, because the two answers depend on each other.

This is general information, not advice on your own situation. Whether any of it applies to you depends on facts this article does not know.