Small Business Retirement Plans
The creation of the Simplified Employee Pension (SEP) and the Savings Incentive Match Plan for Employees (SIMPLE) affords smaller businesses with a way to offer their employees a retirement plan in addition to the 401(k). The SEP and SIMPLE were designed for businesses with less than 100 employees and typically are less costly to administer than a 401(k).
As qualified retirement plans, SEPs and SIMPLEs enjoy the same tax treatment as 401(k)s. Contributions by employees and employers are tax deductible or made on a pre-tax basis. The accumulation inside the accounts grows tax deferred. Many of the same restrictions apply as well. Withdrawals made prior to age 59 ½ may be subject to a penalty.
As with all defined contribution plans, the future retirement benefit is uncertain as it depends on the amount of contributions, how long they accumulate, and the rate of return on the account over that period of time.
The 401(k) plan is one of the most powerful tools a business owner can use to lower their personal taxable income and maximize their savings for retirement.
401(k) plans allow business owners to take a personal tax deduction (their contribution as an employee), a business tax reduction (their contribution as the employer) and potentially, a start-up tax credit for setting up a new retirement plan.
401(k) plans have more flexible savings options than other plans. They allow business owners and their employees to save with a Roth option as well as with a pre-tax option. For employees who are early in their careers, they can pay taxes on their retirement savings while they are in a lower tax bracket. For highly compensated employees, they can use the Roth option to diversify their tax strategy by spreading out the tax burden of their retirement savings.
401(k) plans empower employees to save more by virtue of optional features such as higher contribution limits, auto-enrollment and auto-escalation.
401(k) plans typically integrate seamlessly with payroll to make contributions (and reporting) more streamlined than other offerings.
Sometimes it can make sense to borrow against retirement savings. 401(k) plans provide business owners and their employees the option to take out a loan from their individual account. These loans can be used for practically any purpose or to simply provide a safety net should the unexpected happen like a divorce or disability.
Simplified Employee Pension (SEP)
A SEP is easy to set up and even easier to administer. Each employee establishes their own SEP-IRA to which the employer contributions are made. Although the employer is not required to make a contribution each year, when one is made it must be contributed to all employees over the age of 21, part-time included, based on 25% of covered compensation.1
The employees manage their own SEP-IRAs which can be invested in stocks, mutual funds, money market funds, or fixed investments. The funds are always 100% vested so they can be accessed immediately by the employee (subject to an early withdrawal penalty). Employees with SEP-IRAs can also invest in their own traditional or Roth IRA subject to some income limitations.
For employers, their only responsibility is to make the contribution by their tax filing deadline. There is no administration of the accounts and there is no forfeiture provision to manage.
In a SIMPLE Plan, employees establish their own IRA to which they can electively make tax deductible contributions. Employees who earn at least $5,000 during any two prior years as well as the current year are eligible to participate on a voluntary basis. The maximum amount that can be contributed is $14,000 or 100% of their compensation whichever is less. 2
Employee funds are 100% vested, however, in addition to the normal early withdrawal penalty of 10%, if a withdrawal is made within the first two years of participation, the penalty is 25% unless any exceptions apply.
The employer must match the employee’s contributions up to 3% of their elective deferral, or 2% of all compensation for all employees whether they defer or not. 3
For additional information on small business retirement plans, contact us today.
1 Contributions are limited to 25% of compensation or $61,000, whichever is less.
2 $14,000 is the current maximum and the amount is indexed for inflation.
3 An employer may make less than the 3% contribution for two years out of five year period but it cannot be less than 1%