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Small Business Plans
Self-employed individuals and companies with less than 100 employees.
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. The SEP and SIMPLE were designed for businesses with less than 100 employees and are less costly to administer than a 401(k). For the employees, they are both easy to understand and provide a convenient way to save for retirement.
As qualified retirement plans, SEPs and SIMPLEs enjoy the same tax treatment as other plans. Contributions by employees and employers are tax deductible or made on a pre-tax basis. The accumulation inside the accounts grows tax deferred. The 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. At the time of distribution, withdrawals are taxed as ordinary income with no allowance for 10-year averaging as is available through a 401(k).
Simplified Employee Pension (SEP)
A SEP is easy to setup and even easier to administer. Each employee established 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 covered compensation.1
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 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.
SEP vs. Individual 401(k)
While the SEP is a noncontributory plan, the Individual 401(k) allows for both employer and employee contributions. Both have a $55,000 contribution limit for 2018, but the Individual 401(k) has the age 50+ $6,000 catch-up, and it may allow for a higher contribution percentage of earnings through a combination of employer and employee contributions. Unlike the SEP, the Individual 401(k) allows for loans based on the account value (the lower of 50% or $50,000). The primary disadvantage of the Individual 401(k) is its complexity to both establish and administer.
SIMPLE IRA Plan
In a SIMPLE IRA 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 $12,500 or 100% of their compensation whichever is less.2 Employees age 50 and over may make a $3,000 catch-up contribution.
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, give us a call at 800-345-4635.
1Contributions are limited to 25% of covered compensation (up to $275,000), limited to $55,000 for 2018.
2$12,500 is the current maximum for 2018 with a $3,000 catch up contributions for those 50 and older.
3An employer may make less than the 3% contribution for two years out of five year period but it cannot be less than 1%.