Small Business Retirement Plans
Simplified Employee Pension (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) plans afford smaller businesses ways to offer their employees a retirement plan. SEP and SIMPLE plans are designed for businesses with less than 100 employees and are less costly to administer than 401(k) plans. They are easy to understand and provide employees a convenient way to save for retirement.
SEPs and SIMPLEs enjoy the same tax treatment as other qualified retirement plans. Contributions by employees and employers are tax deductible or made on a pre-tax basis and the assets inside the accounts grow tax deferred. Many of the same restrictions apply as well, for example, withdrawals made prior to age 59 ½ may be subject to a penalty.
At the time of distribution, withdrawals are taxed as ordinary income.
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, a contribution must be made to all employees over the age of 21, including part-time employees, based on 25% of covered compensation.
The employees manage their own SEP-IRAs which can be invested in 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 income limitations.
The only responsibility for employers 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 $11,500 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
There is another version of a SIMPLE called the 401(k) version which is structured much like the IRA version. The advantage of the 401(k) version to the employer is that it can establish stricter requirements for plan eligibility which could reduce the amount of matching contributions. The disadvantage is that the same ERISA reporting rules apply to a SIMPLE 401(k) as they do the regular 401(k), so it can be more costly to administer.
For additional information on small business retirement plans, contact us today.
1 Contributions are limited to 25% of a maximum of $245,000 in 2010 or $49,000.
2 $11,500 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%