Personal Wealth Law News

One of the greatest impediments to retirement by an older generation of a family business is concern about maintaining an adequate income stream in retirement. The owner/managers of a business generally rely upon the business to provide a comfortable income and to cover many expenses. There might be a reluctance to give that up, which could lead to a postponement of retirement beyond what would otherwise be an appropriate time.

We have worked with a number of business owners on this problem, and one helpful solution could be the use of a retirement plan. If there is another, assured source of income, the business owner might be more willing to give up the reins of ownership and management a little sooner. This takes some careful planning, and there are different types of plans that might be appropriate in particular cases. One type of plan that permits the buildup of a large retirement benefit in a short period of time is the defined benefit pension plan. In contrast to the standard 401(k) plan, a defined benefit plan often permits large contributions, which can create a substantial retirement benefit in as little as 5-8 years. There are rules you need to comply with in setting up such plans, but when the situation is right, retirement plans can be an important element of a business succession plan.

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In a prior post, I suggested using your money to set up an IRA for your children, with contributions equal to whatever they earned from summer, or schooltime, jobs. That kind of planning is very valuable, because saving at an early age permits many years of compounding. But there’s a way to make it even better. Most kids who work don’t earn enough from their jobs to generate more than a very small federal income tax or, more often, none. So the IRA tax deduction is of no value. If that’s the case, why not set up a Roth IRA for children’s earnings? There’s no tax deduction for contributions when they are made, but it’s not needed anyway. If the Roth IRA funds are not wihdrawn prematurely, they will be entirely free of federal income tax, and this includes al of the earnings added within the Roth IRA. In the prior post, I calculated that $10,000 at age 25 might grow into $320,000 at 65. With a Roth IRA, that sum will be free of federal income tax. In addition, the Roth IRA funds don’t have to be withdrawn beginning at age 70 1/2, which is required for IRAs and qualified plans, so even more growth is possible. Roth IRAs were only a temporary provision of federal income tax law until last year’s Pension Protection Act made them permanent, so it now seems safe to use them. For the situation of children with summer job earnings, Roth IRAs are the perfect saving vehicle.

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Back when my children had summer jobs, I urged them to save some of the money they earned in a retirement account, an IRA. “If you save now, it will grow into a large amount of money by the time you are 65.” Somehow, promising children age 18-20 wealth when they reached age 65 didn’t sound like an attractive proposition. So they spent their earnings. But I could still set up an IRA for each of them, which I did, and deposited an amount equal to what they earned during the summer (which was less than the maximum that could be contributed). They didn’t pay federal income tax on their earnings anyway, so the IRA deduction wasn’t of any value, but they were started on their way to having a retirement account. Providing I can persuade them not to withdraw the money and spend it before retirement. Suppose they had $10,000 in the account by age 25. If they earned 9% on average until 65, that $10,000 would grow to $320,000. There’s no telling what that will be worth at 65, but it will be a lot more valuable than zero.

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