Like their larger counterparts, a small business can offer retirement plan benefits to their employees affordably using streamlined retirement plans created especially for the small business employer.
The two most common plans – SEP IRA and SIMPLE IRA – are simplified versions of defined contribution plans – profit sharing and 401(k) plans - offered by larger employers.
Each plan is self-managed by the employer – no third-party administrator is required. They work as a loose confederation of employee IRA accounts in which the employer has the responsibility to include all eligible employees in the plan, make plan contributions on a timely basis and to not discriminate in favor of the business owner or key employees. Compliance with plan regulations is monitored by the IRS through audit examination.
The major drawback to conventional retirement plans – the cost to administer and record-keep – is eliminated with SEP/SIMPLE IRA plans. Federal pension law does not apply to these plans either.
A SEP-IRA is a profit-sharing plan; contributions by the employer are discretionary up to 25% of the employee’s compensation with no vesting restrictions. Contributions to an employee’s SEP IRA account are only allowed by the employer and represent additional benefit compensation to the employee. Contributions on behalf of an employee are not subject to income or Social Security taxes for employer or employee.
Like a 401(k) plan, contributions to a SIMPLE IRA plan are a tandem arrangement between employer and employee. The employer has a responsibility to match employee’s elective contributions up to 3% with no vesting restrictions. The employer match is exempt from income tax but not Social Security tax.
As wealth advisors to small business, we have helped many owners successfully implement SEP/SIMPLE IRA plans to the mutual benefit of the employer and employees.
