Retirement Plans for Small BusinessesSubmitted by Alsworth Capital Management, LLC on June 9th, 2017
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 to simplify the administration and reduce the regulatory compliance associated with offering retirement savings plans to employees. The plans are much easier to maintain and less costly than 401(k) plans to administer.
As qualified retirement plans, SEPs and SIMPLEs enjoy the same tax treatment as other more familiar plans. such as corporate 401(k) plans. Contributions by employees and employers are tax deductible or made on a pre-tax basis. The accumulation inside the accounts grows tax deferred. At retirement, withdrawals from the plan are treated as ordinary pension income. Similar to 401(k) plans, they have restrictions on how much money can be contributed to the plans each year. In addition, withdrawals made prior to age 59 ½ may be subject to an early withdrawal 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 investments made within the account over that period of time.
Simplified Employee Pension (SEP)
A SEP is easy to setup 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 a percentage of covered compensation up to 25%.1
As an example, if an employer owner has covered compensation of $100,000 for the year and they decide to contribute 20% ($20,000) to their SEP-IRA account, they must also contribute 20% of each employee’s salary to their respective SEP-IRA accounts. If an employee earns $25,000 for the year, the employer owner must contribute 20% ($5,000) to the employee's account, according to this example.
The plan provides maximum flexibility for the employer owner since they do not have to contribute in a given year. If cash flow is down, they may decide to not contribute to the plan for a given year. The plan does not allow for the employee to contribute to the plan. Only the employer can contribute to the plan and it must be based on an equal percentage of covered compensation for all participants.
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. This plan allows for relatively large annual tax deferred contributions. An employer owner with covered compensation of $270,000 could contribute up to $54,000 per year to the plan. This is a substantially higher annual maximum contribution rate than many other qualified retirement savings plans.
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 for 2017 is $12,500 or 100% of their compensation whichever is less. 2 For employees over the age of 50, they can make an additional "catch up" contribution of $3,000 per year, bringing the total annual maximum contribution amount to $15,500.
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 at 100% of their contribution amount up to 3% of their compensation. Or as an alternative, the employer could elect to simply make a non-elective contribution of 2% of all compensation for all employees whether they defer or not, rather than doing the matching formula. 3
The SIMPLE Plan allows for an easy to maintain retirement savings option for employer owners as well as their employees. The employer contribution requirement is a relatively modest cost to the employer and it allows them to provide a retirement plan and well understood benefit to their employees.
We can review your particular situation and help you determine, which plans would be best for you and your business. We can help you establish and maintain the retirement plans and provide investment and financial planning services to you and your employees.
For additional information on small business retirement plans, contact us today.
Shane M. Alsworth, MBA, CFP®, CLU®, CIMA®
The views and opinions presented in this article are those of Shane Alsworth only
Investments are subject to market risks including the potential loss of principal invested.
1 Contributions are limited to 25% of a maximum of $270,000 in 2017 or $54,000.
2 $12,500 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%