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Retirement Plan Options For Small Business Owners
SEP (Simplified Employee Pension), SIMPLE (Savings Incentive Match Plan for Employees),
and Keogh plans offer small business owners and their employees a tax-favored way to save for their retirement.
But which plan is right for your business? The New Jersey Society of Certified Public Accountants (NJSCPA) provides
the following overview to help self-employed individuals and small business owners understand the costs and benefits
of the various plans.
All of these plans offer two primary tax benefits: (1) contributions you make to the plan for yourself and your
employees are tax deductible and (2) earnings on the contributions are generally tax free until you or your employees
receive distributions from the plan in later years. However, some plans have more restrictions than others and
it is important for you to be aware of these.
SEPs Make Small Work Of Big Savings
A Simplified Employee Pension (SEP) Plan provides small business owners
and self-employed workers with a low maintenance method for contributing to a retirement plan. With a SEP, employers
are not required to file annual tax forms or reports with the IRS. Basically, you set up a plan in each eligible
employee's name and then contribute the same percentage of salary to each account, including your own. SEPs are
funded solely by employer contributions and are not reported on the employee's W2 Form. SEP plans feature flexible
contribution levels that can be adjusted within plan limits from year to year - a plus for businesses that experience
uneven sales results.
Thanks to high contribution levels (the lesser of 15% of salary or $25,500 for employees and the lesser of $25,500
or 13.04% of net income for the self-employed), owners and executives can put away more in a SEP than in a 401(k).
However, because the cost of funding the plan - especially at higher levels - can add up, SEPs tend to be more
attractive for businesses with few or no workers other than the owner.
SIMPLEs Make Retirement Savings Easy
Congress introduced SIMPLE plans in 1997 specifically for small businesses
with 100 or fewer employees. SIMPLEs allow eligible participants to make elective contributions of up to $6,500
per year in 2001, compared with $2,000 in traditional Individual Retirement Accounts (IRAs). Employers must structure
the plan to match (up to 3% of pay) employee contributions or, alternatively, to contribute a flat 2% of pay for
each employee, regardless of whether that employee elects to contribute to the plan.
Although contribution levels for SIMPLEs are significantly lower than some other plans, matching costs can drive
up a business's costs. On the other hand, SIMPLE plans escape many of the burdensome regulations to which other
plans are subject.
Keogh Plans Come in Different Packages
Anyone with self-employment income can open a Keogh, even if covered by
a corporate retirement plan. A plan that covers an owner also must cover all eligible employees.
A Keogh plan may be structured as either a "money purchase" plan or a "profit-sharing" plan.
The profit-sharing Keogh is more flexible in that it allows you to decide each year whether or not to contribute
and how much to contribute to the plan. The money purchase Keogh provides the potential of a larger deduction than
a profit-sharing Keogh, but the trade-off is that you are locked into contributing to the money purchase plan every
year, regardless of your company's profits.
Keogh rules are more complex than those governing SEP and SIMPLE plans. There is both a dollar limit and a percentage
of income limit on how much you can contribute to a Keogh plan each year. The amount depends on whether the plan
is a defined benefit plan or defined contribution plan and whether the contribution is for the benefit of an employee
or a self-employed individual. Because Keoghs allow larger annual contributions than other retirement plans for
self-employed workers, they are popular with high-earning business owners.
Making A Decision
Selecting the right retirement plan for yourself and your business is one of the most important financial decisions
you will make. Once you understand the options, consult with a CPA for advice on establishing a retirement plan
that best meets your personal needs and the needs of your employees.
Published: May 14, 2001
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Money Management is a weekly column on personal
finance distributed by the NJSCPA.
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