More and more companies these days are offering participant-directed investment retirement plans such as 401(k) plans rather than traditional, pooled-investment retirement plans such as trustee-directed profit-sharing and pension plans. However, many of those same employers are hesitant to offer education programs for fear that it might be interpreted as offering investment advice, which could make them legally responsible for participants' investment decisions.
So why should an employer offer an investment-education program? Actually, a well-designed investment-education program can enhance employees' investment performance and minimize employers' liability under ERISA guidelines through tactics designated as so-called Safe Harbors.
A participant-directed investment retirement plan, as opposed to a traditional pooled-investment retirement plan, requires employees to make decisions not only on participating and the amount they want to contribute, but on asset allocation among the plan's investment options as well. Educating employees will help them gain a better understanding of risks and returns. This will provide them with more incentive to improve their understanding of the plan and make them less likely to blame the employer for disappointing investment performance. One caveat: The trustees of the plan are responsible for offering competitive investment options. Even a good investment-education program will not keep employees happy if the investment options are mediocre.
Educated participants also will be better equipped to meet their retirement income goals and limit the employer's liability for the consequences of their decisions. And if the education program encourages lower-paid employees to participate in the plan, higher-paid employees may be able to contribute more money without violating nondiscrimination rules.
In June 1996, the U.S. Department of Labor published guidelines helping employers keep their education programs from violating ERISA rules concerning advice and employers' liability. The DOL bulletin states that employers are providing investment advice, and are therefore liable under ERISA, if both of the following statements are true:
1. The person running the education program gives advice concerning the value of securities or other property or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property.
2. The person running the education program controls the purchasing or selling of securities or other property for the plan participants or gives advice to the participants on a regular basis, and this advice serves as a primary basis for the participants' investment decisions.
Upon determining whether the education program rings true or false with the above statements, the next step to address is so-called Safe Harbors. Following are four categories of investment-related information and materials that employers can use in their programs, and, according to the DOL, will not be considered "advice-giving" under ERISA.
1. Plan information. This is information on benefits available to the participants, how they can increase their retirement-plan contributions, the impact of pre-retirement withdrawals on their retirement income, terms and operations of the plan, and the investment alternatives available to them under their plan.
2. General financial and investment information. This is information on risk and return, diversification, dollar-cost averaging, compounded return, and tax-deferred investment. General financial and investment information also covers differences in return rates among stocks, bonds, cash investments, etc., based on: standard market indexes; the effects of inflation; estimating future retirement income needs; determining investment time horizons; and assessing risk tolerance.
3. Asset-allocation models. This is information and materials concerning hypothetical cases given to plan participants so they can compare and study cases that are similar to their own situations.
4. Interactive investment materials. This includes questionnaires, worksheets, software and other materials that participants can use to plan their retirement investment strategies.
Lastly, it doesn't matter how these four categories, or Safe Harbors, of information are presented to plan participants-meaning that anyone can present the information, including the plan sponsor, fiduciary, or service provider. It also doesn't matter how often the information is presented. The bottom line is that it's in the plan sponsor's best interest to educate employees on how they can reach their retirement goals through their participant-directed plan.
Next month we'll look at developing a participant investment-education program and selecting someone to run it.
Louis P. Stanasolovich is founder and president of Legend Financial Advisors Inc., a North Hills-based, Securities and Exchange Commission registered investment advisory firm that provides asset management and comprehensive financial planning services on a fee-only basis to individuals and businesses. Legend Financial Advisors Inc.'s Website is located at www.legend-financial.com. Stanasolovich can be reached by phone at (412) 635-9210.
Most employers realize it is important for them to provide their employees with investment -elated education, but they do not realize it is better for them as well.
More and more companies these days are offering participant-directed investment retirement plans such as 401(k) plans However, many employers are hesitant to offer education programs because it can be interpreted as offering investment advice, which could make them legally responsible for participants investment performance while minimizing their liability as well. This article will discuss the importance of investment education programs and how employers can use the existing Safe Harbors so as not to be liable for giving investment advice under ERISA guidelines.
Why should an employer offer an investment education program? As opposed to a traditional pooled investment retirement plan, a participant directed investment retirement plan requires employees to make not only decisions on participating and the amount they want to contribute, but asset allocation decisions among the plans investment options as well. Educating employees will help them gain a better understanding of risks and returns. This will provide them more incentive to improve their understanding of the plan and make them less likely to blame the employer for disappointing investment performance. One caveat; it is the trustees of the plans responsibility to offer competitive investment options. Otherwise, even an good investment education program will not keep employees happy if the investment options are mediocre.
Educated participation will be better equipped to meet their retirement income goals and limit the employers liability for the consequences of their decisions. Also, if the education program encourages lower-paid employees to participate in the plan, higher-paid employees may be able to contribute more money without violating nondiscrimination rules.
How the Department of Labor helped? In June of 1996 the Department of Labor (DOL) published guidelines helping employers keep their education programs from violating ERISA rules concerning advice and employers liability. The DOL bulletin states that employers are providing investment advice, and are therefore liable under ERISA, if both of the following statements are true:
- The person running the education program gives advice concerning the value of securities or other property or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property; and
- The person running the education program controls the purchasing or selling of securities or other property for the plan participants or gives advice to the participants on a regular basis, and this advice serves as a primary basis for participants investment decisions.
Upon determining whether the education program rings true or false with the above statements, the next step to address is: Safe Harbors. Following are four categories of investment-related information and materials that employers can use in their programs, and, according to the DOL, will not be considered advice giving under ERISA.
1) Plan Information
This information on benefits available to the plan participants, how they can increase their retirement plan contributions, the impact of preretirement withdrawals on their income, terms and operations of the plan, and the investment alternatives available to them under their plan.
2) General Financial and Investment Information
This is information on risk and return, diversification, dollar cost averaging, compounded return, and tax-deferred investment. General financial and investments, etc. based on standard market indexes; effects of inflation; estimating future retirement income needs; determining investment time horizons; and assessing risk tolerance.
3) Asset Allocation Models
This is information and materials concerning hypothetical cases given to plan participants so they can compare and study cases that are similar to their own situations; and
4) Interactive Investment Materials
This includes questionnaires, work sheets, software, and other materials participants can use to plan their retirement investment strategies.
Lastly, it does not matter how these four categories, or Safe Harbors, of information are presented to plan participants-meaning that anyone can present the information, the plan sponsor, fiduciary, or service provider. It also does not matter how often the information is presented. The bottom line is that it is in the plan sponsors best interest to educate employees on how they can reach their retirement goals through their participant directed plan.
Next month well look at developing a participant investment program and selecting someone to run an investment education program.
For more information on Safe Harbors and participant directed investment retirement plans, call Lou Stanasolovich at (412) 635-9210.
Louis P. Stanasolovich is founder and president of Legend Financial Advisors, Inc., a North Hills Securities and Exchange Commission registered investment advisory firm that provides asset management and comprehensive financial planning services on a fee-only basis to individuals and business. Legend Financial Advisors, Inc.s website is located at www.legend-financial.com. He is a member of the ICFP, the IAFP, NAPFA, and is a co-founder of the Alpha Group. He graduated from the Pennsylvania State University. Mr. Stanasolovich was selected as one of the 200 Best Financial Advisors in America in Worth magazines October, 1996 issue and as one of the 250 Best Financial Advisors in America in Worth magazines October 1997 issue.
Part 1 of a 2-part series
It’s not a revelation that a business’s chosen form must fit your needs, and that these needs and the business itself will change over time. Among other things, the business structure will impact the amount of tax you have to pay. You’ll find distinct advantages and disadvantages with each form of doing business which is why it’s important to annually review your business’ structure.
In recent years, most businesses started in Pennsylvania, other than those in which a single individual is the entire company, have been Subchapter S corporations or Limited Liability Companies (more on this next month), mainly because of the tax advantages. Consider the following.
S corporations, unlike C corporations, are not taxed twice. Owners don’t pay federal corporate tax or Pennsylvania corporate tax, which is 9.999 percent.
The disadvantages are that S corporations can only have a limited number of shareholders (75), and employee benefits. such as medical insurance and group term life insurance, are taxable as ordinary income to employee owners who own more than 2 percent of the subchapter S corporation. In past years, subchapter S corporations were only allowed to have certain types of shareholders, primarily individuals and certain specialized S corporation trusts.
In recent years, the tax law was changed to allow the following types of entities to be shareholders in S corporations: 1) electing small business trusts, 2) qualified retirement plan trusts, and 3) tax-exempt organizations.
If you plan to keep your company private (not a publicly traded entity) for an extended period of time, it usually makes sense to keep it as an S corporation. If the reverse is true, you may want to change to a C corporation.
A primary advantage of a C corporation is the unlimited number and types of shareholders. The differential in the tax brackets between an individual and corporation sometimes makes a C corporation structure more attractive, especially if the C corporation is going to be sold in the near future.
If your personal tax bracket is 39.6 percent and the corporation’s is 15 percent, you can withdraw profits as nontaxable fringe benefits from the corporation or receive a higher value for the corporation when your stock is sold. The gain would be taxed at a maximum capital gains rate of 20 percent.
C corporations can have multiple classes of stock; S corporations can only have one, but these can be voting or nonvoting stock. This counts as one class.
When it comes to liability issues, C and S corporations offer advantages over other forms. Both offer protection from personal liability for business debts. Only the investment is at risk. However, frequently when the corporation, especially if it’s a small one, applies for a bank loan, lead shareholders and their spouses may be required to personally guarantee repayment.
When you review your company’s structure, do so in conjunction with your financial adviser, accountant, and attorney. State income and local taxes should also be considered.
Louis P. Stanasolovich is founder and president of Legend Financial Advisors, Inc., a fee-only North Hills Securities and Exchange Commission registered investment advisory firm that provides asset management and comprehensive financial planning services to individuals and businesses. Reach him at (412) 635-9210. The firm’s Web site is www.legend-financial.com.
The papers have been signed. Money has changed hands. The deal is done. But once you sell your business, the work of getting on with your life has just begun.
After years of building and running a successful business, many business owners seem lost when it comes to continuing on with their lives. They may understand the financial issues they face after the sale of their businesses, but many arent prepared for the psychological and emotional traumas they may experience. Many experts equate the sale of a business with putting ones child up for adoption.
This is how many former business owners feel; therefore, its not surprising that, when its your turn to sell your business, you may have difficulty with some or all of the following:
1) An identity crisis For many years you were the business and vice versa. Once that business is gone, you may not know how to introduce yourself. The question is, what do you call yourself when you are not the president of XYZ Co.?
2) Loss of control For years, you have managed employees. Who will you manage once the deal is done?
3) Transition issues Will you be able to step aside and let others run the company while you gradually ease out of the business?
4) Social adjustments When the business is sold and theres a large influx of money, you may find yourself immensely popular with charities and people selling investments. At the same time, you may start to lose your former industry friends. These are the same people who were a big part of your life when you were at the helm of your business.
5) New social circles With newfound wealth, many will upgrade to a more affluent neighborhood and try to develop friendships with people who may not share the same values. This can be disappointing to someone who is starting a new life.
6) Unrealistic expectations Many former owners fail to calculate taxes on after-sale proceeds and are shocked when they dont receive what they thought they would from the sale of their business.
7) No more expense accounts Once the business is sold, the things that used to be paid through the business, such as health and disability insurance, club memberships, meals, business trips, vacations, etc., must now come from your own pocket.
8) Lack of investment knowledge Many former owners probably reinvested their money into their own businesses. Now they have to invest in the financial markets, which they frequently dont understand, to keep their money growing.
Despite such changes, the situation is not as grim as it might seem and can be viewed as a new opportunity. The following can help former business owners transcend their old lives for something much more exciting:
Rent an outside office and spend time there at least a few days a week. This will give you a chance to tie up loose ends while preserving your familys sanity.
Postpone any major decisions regarding investing in the securities markets or purchasing another business for the first year after the sale. Sometimes, it is better to research options thoroughly than to rush into something without a great deal of thought behind it.
Take a family vacation. Taking time to play is a reward for many years of hard work.
Consider volunteering in local business organizations that help small businesses or in the businesses themselves. Part-time and full-time opportunities for pay sometimes are available for consultants, boards of directors and advisory boards.
Louis P. Stanasolovich, CFP, is founder and president of Legend Financial Advisors, Inc., a fee-only Securities and Exchange Commission registered investment advisory firm located in the North Hills. Reach him at (412) 635-9210. The firms Web site is www.legend-financial.com.
Hiring family members can qualify family business owners for special tax savings.
Indeed, hiring family is an excellent way to save money on federal income taxes. A spouse who works for a family business but is not covered by a qualified retirement plan can contribute up to $2,000, or 100 percent of earned income, to an IRA. For immediate benefit, the spouses salary can be deducted, which creates an extra $2,000 of tax-free income for the family.
The long-term benefit is that this money will accrue tax-free as long as it remains in the IRA. If you put it into a Roth IRA, its not tax deductible, but it will grow tax-free and distributions will never be taxed.
You also can save on taxes by hiring family members who are minors, since income earned by your minor children is taxed at their rate, usually 15 percent or less. Your business will also get a deduction for their salary.
To stay out of trouble with the IRS, keep detailed records. For the working spouse, records must show the spouse actually did the work for which he or she was paid. For the working children, records must show that they did the work, it was necessary for the business, and if they hadnt done it, the family would have had to hire someone.
The other deduction family business owners can take is the spouses expenses on business trips. Normally you cant deduct such expenses, but if you can prove the spouse is essential to the purpose of the trip, the expenses are an allowable deduction.
Consider these examples of when a spouses presence would be necessary:
1) The owner is traveling to another country and doesnt know the language and customs, but the spouse does.
2) The spouse is the secretary on the trip and is familiar with the technical details.
3) The client has requested the spouses presence.
Business owners also have been allowed this deduction when they showed they had an illness such as diabetes and the spouse was trained as the nurse; they proved the spouse wasnt enthusiastic about the trip; or they proved their spouses had not participated in any type of tourist activity.
If this spousal deduction werent allowed, however, you still could deduct what it would have cost to travel alone. You may not be permitted to deduct the cost of a double-occupancy room, but you could deduct the cost of a single room.
On top of spousal deductions, you can save taxes with a company car. Drive the car until its fully depreciated, then switch it over for personal use without tax liability. The car wont become taxable until its sold.
Overall, when owning a business, youll find it extremely worthwhile for financial reasons to hire family members. Utilization of simple tax strategies can ensure the financial rewards.
Louis P. Stanasolovich is president of Legend Financial Advisors Inc., a fee-only North Hills registered investment advisory firm that provides asset management and comprehensive financial planning services to individuals and businesses. Its Web address is www.legend-financial.com.
Most entrepreneurs go into business for financial freedom and the challenge. And for some, one business isnt enough.
Still, whether this is your first or seventh venture, its important to do your homework when buying an existing business.
The benefits of buying an existing business are obvious: The business will bring with it established customers, suppliers, employees, a name and reputation. Failure rates for existing businesses are lower than those of new businesses.
However, as part of the due diligence process and before you jump into anything, make sure you inquire about why the business is for sale. Turnaround projects are always risky, especially if the purchaser doesnt have experience in this area.
Before you even begin to explore opportunities, yput together a team of specialists, including an attorney, accountant and perhaps even a banker (if a loan will be needed to fund the acquisition), who can give you greater credibility in investigating potential acquisitions.
When you identify an opportunity, this team should review all of the financial information available on the business. In the best-case scenario, the new acquisition should pay a competitive salary for either the owner, if hes going to be active in the business, or an operations manager, if the owner isnt going to be active plus a healthy profit.
The definition of a healthy profit should include a return that equals the long-term return of the stock market, (11 percent) plus 4 or 5 percent. This extra return should be sought because a privately owned business is illiquid, which means you should be compensated for that illiquidity.
Frequently, the return on the business is dictated by the purchase price, which needs to be determined by evaluating the financial statements and operations. To determine whether to purchase a business and what to pay for it, you need to obtain the appropriate financial information from the existing business owner.
This should include income statements and balance sheets, income tax returns for the last three to five years, accounts receivable and payable records, leases held by the business, customer and supplier contracts, patent or trademark information, insurance policies and employee fringe benefits. If the seller doesnt want to provide this, its best to walk away from the negotiating table.
Generally a full-scale audit should be considered. Under the best circumstances, it should be performed by an accounting firm with experience in that industry but which doesnt have any ties to either the buyer or seller. The audit fee could be split by both parties.
Financials aside, try to gain insight into how the company is run by volunteering to work in the business for a week or two. Also ask customers, other business owners, and suppliers about the companys reputation.
After all, when considering to buy a business, the more information you have, the better.
Louis P. Stanasolovich, CFP, named as one of the best financial advisers in America the last four years by Worth magazine, is founder and president of Legend Financial Advisors, Inc., a fee-only Securities and Exchange Commission registered investment advisory firm located in the North Hills. Legend provides asset management and comprehensive financial planning services to individuals and businesses. Reach him at (412) 635-9210. The firms Web address is www.legend-financial.com.
Most successful business owners routinely use a business plan to stay on track, seek financing, re-energize their companies, or arrange strategic alliances.
The purpose of the business plan is to make a commitment on paper to a plan of attack, which will determine the direction the business is moving. It should also determine the exact strategy and tactics, the risks and rewards. Heres where you should begin:
A business plan should be set up with a cover page and a table of contents. Each section should be tabbed and neatly labeled.
This is the whole business concept in a nutshell - a complete summary of the rest of the plan. Starting with when and how the business began and ending with projections, this section briefly describes the product/service, what separates the business from the competition, what makes the business successful and what it needs to do to become even more successful.
This should be two pages at most. If it is not well written to compel the reader to continue, it will not get read and ultimately will end up in the round file.
The mission statement is the rudder of the business. It briefly states what the business is about what its mission is and is often used in marketing materials.
Background and business concept
Also know as the company, this section picks up where the executive summary left off. Basic information about the company, its past, present and future, should be provided here.
What customer groups are targeted? Who is the competition? What is the market? Why would it be interested in that service or product?
Your product or service
What is it? What makes it special or attractive? What does it cost? Are there warranties? How will the product or service be produced and/or distributed? How will the business be promoted? How will the business attract new customers? Is there an in-house sales force? Will the company sell through manufacturers representatives, telemarketers, direct mail or the Internet?
Management team and objectives
Whos running the business and what goals are they required to meet? Is the management team deep or thin? What is its previous experience?
Financial statements should be done on a cash basis. What are the businesss expenses and revenue sources? The more detail the better. This section should include the exit strategy.
Summarize the rest of the plan and key issues.
Assets and liabilities must be included in this section. Personal financial statements and biographies of the principals also should be included here. Louis P. Stanasolovich, named one of the best financial advisers in America the last four years by Worth magazine, is founder and president of Legend Financial Advisors Inc., a fee-only financial advisory firm located in the North Hills. Legend provides asset management and comprehensive financial planning services to individuals and businesses. Reach him at (412) 635-9210 or via his firms Web site at www.legend-financial.com.
Self-employed individuals make up the fastest-growing segment of the business community.
Unfortunately, many self-employed entrepreneurs believe that, because they are on their own, they don't have access to retirement plans. They don't realize they have access to a variety of plans to shelter income for their retirement. Most have limits, but they far exceed the limits for IRAs.
These plans, known as profit-sharing plans and money purchase pension plans, can cover the self-employed person as well as incorporated businesses. With a profit-sharing plan, you can contribute as much as 15 percent of your first $170,000 of compensation in the year 2000.
For money purchase pension plans, you can contribute as much as 25 percent of your first $170,000 of compensation in 2000. Businesses can have both types of plans, but participants, including owners, can contribute no more than $30,000.
With a money purchase pension plan, you must make contributions every year. With a profit-sharing plan, the contributions are at your discretion. Therefore, many self-employed people establish both types of plans.
However, they typically make maximum contributions to the profit-sharing plan (contributions are optional if the business gets in financial trouble) and minimal contributions to the pension plan -- but enough to maximize the $30,000 contribution.
Under a Simplified Employee Pension (SEP) plan, those of you who employ others can contribute toward your employees' retirement. You simply have each employee establish an IRA wherever he or she would like. SEP rules allow you to make yearly maximum contributions of up to 15 percent of an employee's compensation or $30,000, whichever is lower, to a SEP-IRA for each participating employee. You then can use these contributions as a tax deduction.
As with a profit-sharing plan, it's not mandatory to contribute to your employees' SEP-IRAs, but if there are contributions, they must be based on a written allocation formula and cannot favor highly compensated employees. After the contribution is made to the SEP IRA for each employee, the rules for traditional IRAs apply.
If you're self-employed, you have to consider special rules when calculating the maximum deduction for contributions. According to the IRS, your limit is equal to your net earnings. The IRS provides a worksheet in Pub. 590, chapter 4, that can help you make these calculations.
Savings Incentive Match Plans for Employees (SIMPLE) cover employers with 100 or fewer employees. Retirement accounts under this plan can be set up as a 401(k) SIMPLE plan or a SIMPLE IRA plan.
Under a SIMPLE IRA plan, employees can choose to reduce their pay a certain percentage each pay period and allow the employer to contribute that amount to the IRA. You also can make matching contributions of up to 3 percent of salary to only those employees who participate by reducing their salaries or nonelective contributions of up to 2 percent of salary to all eligible employees, regardless of whether they participate by making elective salary contributions.
To be eligible, employees must earn at least $5,000 during any two years prior to the current year and expect to earn at least that much during the current year. Maximum elective contributions, adjusted for cost-of-living increases, are $6,000 for employee-deductible deferrals. With a matching employer contribution, the total potential contribution to a SIMPLE-IRA could be $12,000 a year for the most highly compensated employees.
A 401(k) SIMPLE plan is merely a qualified 401(k) plan that adopts some of the SIMPLE rules to satisfy annual nondiscrimination tests. Louis P. Stanasolovich, named one of the best financial advisers in America the last four years by Worth magazine, is founder and president of Legend Financial Advisors, Inc., a fee-only financial advisory firm located in the North Hills. Reach him at (412) 635-9210. The firm's Web site is www.legend-financial.com.
Being appointed a corporate director certainly is an honor. But it's also a responsibility.
Like it or not, directors are responsible for the corporation's property and finances, which means the directors must conduct and manage the corporation's affairs in good faith. Acting negligently and beyond their powers could make directors financially responsible for the corporation's losses. In the eyes of the law, ignorance on the director's part is not an excuse.
So, before you accept your next corporate directorship, it's important to know what the responsibilities will include, what level of care and diligence is expected, and how much you need to know about the company's corporate affairs.
Directors also should have a general understanding of taxation, since many of their decisions on the corporation's finances will have an impact on the company's tax liability. If it's proven that the corporation must pay penalty taxes because of a director's decision or action, the director(s) could be held financially liable.
To protect against penalty tax liability, all of the directors should keep a current record showing that the company retained its earnings for the reasonable needs of the business and that it had instituted plans to use this surplus. For example, plans for the surplus could include a building reserve, architect's plans, contractor's bids, etc.
Knowing specifically what constitutes negligence is an important first step. For instance, are directors responsible for corporate losses if they are acting on the advice of other professionals, i.e. an accountant or attorney? If the misguided advice is the whole cause of the problem, and the director acted in good faith, the answer is no.
Directors also are not responsible for the negligent acts of others as long as they didn't know about the action or had their dissenting vote recorded in the minutes.
Director liability can extend to creditors. If the directors approve a business action without the necessary capital to see it through, they are liable to the creditors. And if they pay themselves ridiculously large salaries or make it impossible for creditors to collect, they are liable.
To minimize your liability as a director, take the following steps:
1. Don't skip directors' meetings.
2. Take good notes and file them consistently.
3. Understand the financial reports and legal opinions prepared by the corporation's accountants and lawyers.
4. Make sure any dissenting vote or disapproval of an officer's or director's action is recorded in the minutes.
5. Read the minutes of all meetings and make sure all disapprovals are noted.
6. Consider resigning if you emphatically disapprove of an action or cannot attend meetings regularly.
In general, you would not be liable for losses suffered by the corporation as a result of poor judgment if you have acted honestly and within your powers. However, the best defense is to obtain a significant amount of directors' and officers' liability coverage in the form of an insurance policy.
The corporation typically purchases this type of policy on behalf of the board of directors and its corporate officers. These policies, while expensive, are worth the cost, especially in light of the potential liability. Louis P. Stanasolovich, named one of the best financial advisers in America the last four years by Worth magazine, is founder and president of Legend Financial Advisors Inc., a fee-only financial advisory firm in the North Hills. Reach him at (412) 635-9210. The firm's Web site is located at www.legend-financial.com.