One of the challenges that many self-employed individuals face is choosing the right retirement plan to meet their needs. Qualified retirement plans can be difficult to set up and administer, with many rules and tests under I.R.S. and ERISA regulations, leading to substantial costs. The Simplified Employee Pension Plan (SEP), however, is a simplified alternative to traditional retirement plans. A SEP is relatively easy to adopt and administer, and offers flexibility to the small business owner with few employees.
SEP-IRA plans are available to S corporations, C corporations, partnerships and sole proprietorships. A SEP-IRA plan is adopted and fully funded by the employer; employee contributions are not permitted. Each participant in the plan has an individual retirement account set up in his or her own name, and the employer makes contributions to each account. The participant is then responsible for the management of the assets within the account.
All employees are eligible to participate in the plan provided they are at least 21 years old, have worked for the employer during the year for which the contribution is made, and have satisfied other participation requirements. If an employer chooses to make a contribution in a given plan year, the contribution must be made for all eligible employees.
All SEP-IRA contributions are immediately vested and not forfeitable by the participating employees.
Plan contributions are limited to the lesser of 25% of compensation up to a maximum compensation of $230,000 in 2008, or $46,000. The $230,000 maximum compensation amount is indexed to inflation in future years in $5000 increments. The contribution limit will also be subject to future cost of living adjustments. An employer can make different contributions from year to year, provided that, in any one year, all employees receive contributions equal to the same percentage of their compensation and the contributions do not exceed the maximum contribution limits.
The contributions are tax deductible for the employer. In order for contributions to be deductible in a given tax year, they must be made by the date that the employer’s tax return is filed.
The primary advantage of this plan is the ease of adoption and administration. Also, the employer is relieved from fiduciary responsibilities, as each employee directs the investments in their own account. Another advantage is that the employer may change the contribution percentage from year to year, of particular importance to businesses with irregular annual cash flows.
There are, however, some drawbacks which you should consider. The eligibility rules for participation are very loose, requiring contributions for even part-time and seasonal workers. Each participant is also immediately vested in the full amount of any contribution. These two factors could result in higher costs to the employer, and lessen the plan’s impact as an incentive for employee retention. The plan is also subject to top-heavy rules, which could require greater percentage contributions to lower paid employees.
A profit sharing plan has the same contribution and compensation allowances, but allows a range of vesting schedules that can save an employer money. In addition, the SEP-IRA is not considered an ERISA-qualified plan like a profit sharing plan. It does not, therefore, enjoy the higher level of creditor protection that other retirement plans may offer.
There are other types of retirement savings plans designed for small business owners that are worth your consideration, including Profit Sharing, Defined Benefit, Individual 401(k) and Simple IRA plans. We at Bingham, Osborn and Scarborough, LLC can discuss with you the relative advantages and disadvantages of each plan and assist you in deciding on the best plan for you and your business.
For additional information on this or related topics, or to learn more about the investment management and financial planning services offered by Bingham, Osborn & Scarborough, LLC, please visit our website at www.bosinvest.com.
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