Retirement Planning

Retirement and Financial Planning

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It’s Never Too Early to Start Planning

  1. Retirement and Financial Planning
  2. It’s Never Too Early to Start Planning
  3. Introduction
  4. Types of Retirement Plans
  5. The Goals of Retirement Planning
  6. Special Retirement Planning Concerns of Business Owners
  7. Investment Choices
  8. Investing in the Business
  9. Providing a Nest Egg
  10. Income Stability
  11. The Importance of Planning Early
  12. Tax-Deferred Compounding
  13. Sources of Retirement Funds
  14. Pensions and Other Retirement Plans
  15. Pension Plan Basics
  16. Help with Choosing a Retirement Plan
  17. Choosing a Plan
  18. Qualified Plans
  19. ERISA
  20. Complexity and Flexibility
  21. Social Security
  22. What It Pays
  23. Obtaining an Estimate of Social Security Benefits
  24. Taxation of Benefits
  25. Resources for Additional Information
  26. Retirement Planning FAQs
  27. Retirement Planning At-A-Glance
  28. Forms and Checklists
  29. For More Information
  30. Back to Personal Finances


Most workers, business owners and professionals, work all their lives to accumulate a sufficient nestegg to provide a comfortable, independent retirement for themselves and their families. Retirement planning is an ongoing process that must begin well before retirement and continue into retirement, to assure coordination with estate planning—and both require advance planning and continuous reevaluation. This section discusses the various types of retirement plans available, including the “old-reliable” tax-qualified plans and the increasingly popular nonqualified plans.

Types of Retirement Plans

The Goals of Retirement Planning

The objectives of retirement planning are to save and acquire sufficient (liquid) assets to achieve retirement goals. Most workers would like to acquire enough wealth to:

  •  Provide for unexpected or major expenses during their working years;
  •  Be financially independent during their retirement years;
  •  Continue to live in the same lifestyle, or better, in their retirement years than during their working years; and
  •  Be able to pass along a substantial portion of their wealth to their heirs.

There are numerous additional factors to consider when planning for retirement. These considerations include:

  •  Early or later retirement;
  •  Medical problems;
  •  Work after retirement;
  •  Housing needs;
  •  Lifestyle changes; and
  •  Providing for spouse, heirs, or others.

These goals require vigilant planning and constant monitoring. Without a properly designed plan—and regular, systematic updating of that plan—these goals will be difficult to achieve, if they can be reached at all.

Special Retirement Planning Concerns of Business Owners

For many small business owners, retirement planning is often interrelated with business succession planning, because business owners may need to rely on the proceeds from the disposition of their businesses to fund their retirement. Although business owners generally have several choices in selecting company-sponsored pension plans, the realities of pension plan costs and administrative headaches often dictate that many business owners who have employees will either have a nominal plan that does not provide them with sufficient retirement income or, worse, no plan at all. Business owners who have no employees can easily set up a self-employed pension plan (SEP).

Many independent businesspeople simply assume that the eventual sale of their business will fund their retirement. But most small businesses and professional practices cannot be easily sold or liquidated. Selling a closely held business is often a tricky and difficult proposition. And owners frequently think their businesses are worth a lot more than they actually are. Self-employed professionals and small business owners who do not provide retirement plans at their place of business should, therefore, establish and maintain their own retirement plans and other investment accounts, sufficient to provide for a financially comfortable retirement.

For all individuals, accumulating wealth to provide a nestegg should be a high priority in the overall financial, retirement, and estate plan. But for business owners, accumulating wealth outside the primary business or profession is usually necessary as a hedge against business slowdowns, downturns, and general economic uncertainties.

Investment Choices

The three major investment tools used for capital accumulation outside of the business are the same investments used by any investor interested in accumulating capital for a comfortable retirement:

  1. Stocks, including other equity investments;
  2. Bonds and other interest-earning investments; and
  3. Real estate.

Investing in the Business

When business owners invest in their own businesses, the risks are tied to the risks inherent in most businesses. Knowing these risks should help to determine the amount of capital to invest in the business in proportion to outside investments. Although every industry and profession has its own risks and rewards, the following are typical:

  • Rising costs;
  • Decreased demand for product or service;
  • Increased competition; and
  • Recession.

On the other hand, investments in large, diversified corporations are generally less subject to these risks than are investments in small companies.

Providing a Nest Egg

One investment objective of many small business owners and self-employed professionals is to provide a nest egg outside the business to prepare for a possible or periodic time of lower income resulting from a downturn in the business. This means, among other things, that the need for a substantial “emergency fund” as well as the ability to turn this money into cash quickly may be particularly important.

Income Stability

The importance of income stability often depends on an investor’s stage in life. Business owners and professionals who are accumulating a retirement nest egg have less need for stability than retirees who rely on investment income to help meet living expenses.

Whatever an investor’s age or circumstances, an overemphasis on stable income will usually impair the capital appreciation potential of a portfolio because lower risk (of fluctuation in, or reduction of, income) generally corresponds to lower reward (of growth in value).

The Importance of Planning Early

Because planning is so crucial to achieving retirement goals, the planning process—and it is an ongoing process—must begin well in advance of the retirement years. How early will depend on each particular situation, and the planning may take on a somewhat different approach and strategy, depending on the individual’s stage in life. Suffice it to say that it would not be too soon for a thirty-something business owner or employee to start thinking about funding his or her retirement.

Tax-Deferred Compounding

Why start early? Not only will starting early translate into additional retirement funds, but an earlier start also will provide more opportunity to take advantage of the benefits of compounding. Compounding makes money work harder, and its effect becomes more pronounced if it is allowed to work longer. Moreover, taking advantage of certain deferred-payment vehicles may save tax dollars currently and in the future!

Sources of Retirement Funds

There are basically three sources of retirement income:

  1. Business (wages, salary) and investment income;
  2. Pension and other retirement plans; and
  3. Social security.

As we all know, and have read and heard about recently in the popular media, social security is becoming less and less reliable. Even if the benefits will be there when we need them, the actual economic benefits of the funds are eroding daily; with the effects of inflation factored in—even at today’s lower levels—the buying power of a social security check will not go as far as it might have in the past. That is why the first two retirement funding sources are becoming more and more important. And early planning is essential to making those two income sources viable. The following sections provide an overview of the various retirement plans available to business owners, employees, and self-employed individuals.

Pensions and Other Retirement Plans

Pensions and other retirement plans often form a major part of the estates of executives and other highly paid employees. The small business owner, on the other hand, is usually faced with a double-edged sword in this respect: the cost of setting up a plan may seem prohibitive, yet the economic realities of retiring without the benefit of plan assets will be an even greater shock. The extent to which a pension plan can contribute to meeting an individual’s retirement income needs can vary greatly. Business owners have a great deal of latitude in setting up company retirement plans. Depending on particular circumstances, there are several types of plans available.

Pension Plan Basics

A pension plan is a plan designed to provide for the livelihood of employees (and their beneficiaries) after the retirement of the employee.

    1. A pension plan, usually established by the employer, consists of a formal written program providing benefits to employees or a group of employees.
    2. The plan’s main objective is to provide retirement income to employees, with an emphasis on benefits payable after retirement.
    3. A pension plan may be a defined benefit or defined contribution plan.

Help with Choosing a Retirement Plan

Resources to help you compare retirement plan options

Tips for Employers Using Pre-Approved Plans
Questions to ask your service provider about your prototype plan adoption and service agreements.

Benefits to Starting a Retirement Plan
Why the right retirement plan is your best bet for retirement security.

Webcast – Easy Low Cost Retirement Plans for Your Small Business
How to start and operate a low-maintenance retirement plan.

Choosing a Plan

A pension plan is an employee benefit plan established or maintained by an employer or by an employee organization (such as a union), or both, that provides retirement income or defers income until termination of covered employment or beyond. There are a number of types of retirement plans, including the 401(k) plan and the traditional pension plan, known as a defined benefit plan.

Qualified Plans

Qualified plans are retirement plans that satisfy a complex set of conditions and requirements for tax qualification under Section 401(a) of the Internal Revenue Code. A qualified plan offers a combination of tax benefits that are not available through any other type of program.


The Employee Retirement Income Security Act of 1974 (ERISA)  is a federal law that sets minimum standards for pension plans in private industry.

ERISA does not require any employer to establish a pension plan.  It only requires that those who establish plans must meet certain minimum standards.

See also: What is ERISA?

A defined benefit plan promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service — for example, 1 percent of average salary for the last 5 years of employment for every year of service with an employer. The benefits in most traditional defined benefit plans are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC).

A defined contribution plan, on the other hand, does not promise a specific amount of benefits at retirement. In these plans, the employee or the employer (or both) contribute to the employee’s individual account under the plan, sometimes at a set rate, such as 5 percent of earnings annually. These contributions generally are invested on the employee’s behalf. The employee will ultimately receive the balance in their account, which is based on contributions plus or minus investment gains or losses. The value of the account will fluctuate due to the changes in the value of the investments. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans.

A Simplified Employee Pension Plan (SEP) is a relatively uncomplicated retirement savings vehicles. A SEP allows employees to make contributions on a tax-favored basis to individual retirement accounts (IRAs) owned by the employees. SEPs are subject to minimal reporting and disclosure requirements. Under a SEP, an employee must set up an IRA to accept the employer’s contributions. Employers may no longer set up Salary Reduction SEPs. However, employers are permitted to establish SIMPLE IRA plans with salary reduction contributions. If an employer had a salary reduction SEP, the employer may continue to allow salary reduction contributions to the plan.

A Profit Sharing Plan or Stock Bonus Plan is a defined contribution plan under which the plan may provide, or the employer may determine, annually, how much will be contributed to the plan (out of profits or otherwise). The plan contains a formula for allocating to each participant a portion of each annual contribution. A profit sharing plan or stock bonus plan include a 401(k) plan.

A 401(k) Plan is a defined contribution plan that is a cash or deferred arrangement. Employees can elect to defer receiving a portion of their salary which is instead contributed on their behalf, before taxes, to the 401(k) plan. Sometimes the employer may match these contributions. There are special rules governing the operation of a 401(k) plan. For example, there is a dollar limit on the amount an employee may elect to defer each year. An employer must advise employees of any limits that may apply. Employees who participate in 401(k) plans assume responsibility for their retirement income by contributing part of their salary and, in many instances, by directing their own investments.

An Employee Stock Ownership Plan (ESOP) is a form of defined contribution plan in which the investments are primarily in employer stock.

A Money Purchase Pension Plan is a plan that requires fixed annual contributions from the employer to the employee’s individual account. Because a money purchase pension plan requires these regular contributions, the plan is subject to certain funding and other rules.

A Cash Balance Plan is a defined benefit plan that defines the benefit in terms that are more characteristic of a defined contribution plan. In other words, a cash balance plan defines the promised benefit in terms of a stated account balance. In a typical cash balance plan, a participant’s account is credited each year with a “pay credit” (such as 5 percent of compensation from his or her employer) and an “interest credit” (either a fixed rate or a variable rate that is linked to an index such as the one-year treasury bill rate). Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts promised to participants. Thus, the investment risks and rewards on plan assets are borne solely by the employer. When a participant becomes entitled to receive benefits under a cash balance plan, the benefits that are received are defined in terms of an account balance. The benefits in most cash balance plans, as in most traditional defined benefit plans, are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC).

Complexity and Flexibility

Defined benefit plans are substantially more complex and less flexible than defined contribution plans. Other considerations regarding defined benefit plans include the following:

  1. Significant excise tax penalties are triggered if surplus assets exist at the time of plan termination or if the minimum funding rules are not followed.
  2. If insufficient assets exist in the plan at the time of plan termination, the employer would be required to make additional contributions to satisfy the plan’s liability to employees.
  3. Defined benefit plans are more expensive to administer because outside actuarial services are required.

CAUTION: In designing the features of a plan, care must be taken to assure that the plan does not discriminate in favor of the highly compensated employees. If the plan by its terms or in operation results in prohibited discrimination, the plan’s qualification would be lost, and the tax benefits afforded qualified plan status would be forfeited.

Social Security

Social security is the third leg of the three-legged retirement stool. It is intended to be a supplement to other forms of retirement income (including investment income and retirement plan funds). It is not to be viewed as a replacement or substitute for earnings. As a general guideline, social security benefits can supplement about one-third to one-half of regular earnings.

Most people think of social security as simply a pension plan for their retirement. But what many people do not realize is that social security is also a system that replaces income lost by a disabled worker or the family of a deceased worker, regardless of age.

What It Pays

Social security pays four types of benefits:

    1. Retirement insurance. Social security pays a monthly benefit upon retirement, from age 62 on, for life. Spouses and children may be eligible for benefits, too.
    2. Survivor’s insurance. This is like life insurance. In the event of the worker’s death, the spouse and children may be entitled to benefits. In some cases, parents may also be eligible for benefits.
    3. Disability insurance. The disability benefit of social security assures that a monthly income will be available in the event of illness or injury. Spouses and children may also be entitled to benefits.
    4. Medicare. The Medicare program— often confused with the Medicaid program, which covers the indigent— provides hospital and medical insurance. The medical insurance requires a small additional monthly premium, but there is no premium for Medicare hospital insurance.

For more information on Social Security retirement benefits click here.

Obtaining an Estimate of Social Security Benefits

The Social Security Administration (SSA) will provide a personalized benefit estimate if requested. Click here for the SSA Retirement Estimator. The Retirement Estimator gives estimates based on your actual Social Security earnings record.

Taxation of Benefits

All or a portion of an individual’s retirement benefits may be subject to taxation— either income tax at the time of receipt or estate tax at death. Lump-sum distributions from retirement plans, for example, are generally subject to income tax, although certain adjustments can reduce the taxable amount. There are some options available that can reduce, postpone, or in some cases eliminate the tax burden.

Resources for Additional Information

The Small Business Retirement Savings Advisor
Provides information about retirement savings options for small business employers and can help to determine which program is most appropriate for a business.

Easy Retirement Solutions for Small Businesses
Provides information about retirement plan options for small businesses.

Savings Incentive Match Plan for Employees of Small Businesses
Provides information about the basic features and requirements of SIMPLE plans that involve individual retirement accounts or annuities (SIMPLE IRAs).

SEP Retirement Plans For Small Businesses
Provides a guide to Simplified Employee Pensions for small businesses.

Video Webcast: The Latest Retirement News and Hot Topics

Retirement Planning FAQs

  1. What challenges face individuals planning for an adequate retirement?
  2. Should self-employed professionals and small business owners establish their own retirement plans?
  3. What is a pension plan?
  4. What types of plans are available?
  5. What is a “qualified plan”?
  6. What is a defined contribution plan? A defined benefit plan?
  7. Are plan contributions tax-favored?
  8. Are there limits on the amount of money that can be contributed to the plan each year?
  9. Can a self-employed individual establish a retirement plan?
  10. Are there any provisions for taking an early withdrawal from a plan?
  11. What factors affect how much an individual will receive in social security benefits?
  12. Does social security provide any family benefits?
  13. What types of benefits does social security provide?
  14. Must self-employeds pay social security taxes? If so, are the rates the same as for employees?
  15. How are retirement benefits taxed upon distribution? Is there any way to reduce or avoid the tax?
  16. Are Social Security benefits taxable?

Retirement Planning At-A-Glance

    1. Individuals planning for an adequate retirement face challenges that include providing for unexpected or major expenses during their working years and continuing to live in the same lifestyle, or better, in their retirement years.
    2. Self-employed professionals and business owners without employees can set up self-employed pension plans. Business owners may find the costs and administrative obligations of company-sponsored pension plans prohibitive.
    3. A pension plan is a plan designed to provide for the livelihood of employees and their beneficiaries after retirement.
    4. An employer can offer several types of pension plans, including money-purchase pension plans, profit sharing plans, and 401(k) plans.
    5. Most plans are qualified plans. Qualified plans provide for tax deferral and other tax benefits but must comply with a complex set of rules.
    6. Defined contribution plans promise that certain contributions will be credited to the employee’s account and that the employee will be entitled to all or part of the value of this account at retirement. Defined benefit plans are qualified retirement plans that promise specific benefits at retirement.
    7. A qualified plan is tax exempt, and therefore any earnings on plan assets are not subject to taxation until distributed. A deferred compensation plan that is qualified enjoys special tax treatment.
    8. There are limits on the amount of allocations that can be made annually to a participant’s account in defined contribution plans, and on the amount of benefits that can be accrued in a defined benefit plan.
    9. There is a type of tax-favored deferred compensation arrangement that is considerably simpler and less expensive to administer. These arrangements are referred to as simplified employee plans, or SEPs.
    10. Early withdrawals may be taken from a plan, but they may be subject to a penalty.
    11. How much an individual will receive from social security benefits will be determined by such factors as age of retirement.
    12. Social security may pay benefits to family members who are children, surviving spouses, or, in some cases, parents.
    13. Social security pays four types of benefits: retirement insurance, survivor’s insurance, disability insurance, and Medicare.
    14. Self-employed individuals pay social security through an annual self-employment tax. Although the rates are the same as for employees, self-employeds must pay the entire 15.3%.
    15. All, or a portion, of an individual’s retirement benefits may be subject to taxation— either income tax at the time of receipt or estate tax at death. There are some options available that can reduce, postpone, or in some cases eliminate the tax burden.

Forms and Checklists

For More Information

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