Perhaps you are thinking about
setting up a retirement plan for yourself and your employees, but are concerned
about the financial commitment and administrative burdens involved in providing
a traditional pension or profit-sharing plan. An alternative program you may
want to consider is a “simplified employee pension,” or SEP.
SEPs are intended as an alternative to
“qualified” retirement plans, particularly for small businesses. The relative
ease of administration and the complete discretion you, as the employer, are
permitted in deciding whether or not to make annual contributions, are features
that are especially attractive. Here's how these plans work.
If you don't already have a
qualified retirement plan, you can set up a SEP simply by using the IRS model
SEP, Form 5305-SEP. By adopting this model SEP, which doesn't have to be filed
with the IRS, you will have satisfied the SEP requirements. This means that
you, as the employer, will get a current income tax deduction for contributions
you make on behalf of your employees. Your employees will be taxed not when the
contributions are made, but at a later date when distributions are made, usually
at retirement. Depending on your specific needs, an individually-designed
SEP—instead of the model SEP—may be appropriate.
When you set up a SEP for
yourself and your employees, you will make these deductible contributions to
each employee's IRA, called a SEP-IRA, which must be IRS-approved. The maximum
amount of deductible contributions that you can make to an employee's SEP-IRA,
and that he or she can exclude from income, is the lesser of: (i) 25 percent of compensation, and (ii) $42,000 (for 2005).
The deduction for your contributions to employees' SEP-IRAs isn't limited by
the deduction ceiling applicable to an individual's own contribution to a
regular IRA. Your employees control their individual IRAs and IRA investments,
the earnings on which are tax-free.
There are other requirements
which you have to meet to be eligible to set up a SEP. Essentially,
all regular employees must elect to participate in the program, and
contributions can't discriminate in favor of the highly compensated employees. But
these requirements are minor compared to the bookkeeping and other
administrative burdens connected with traditional qualified pension and
profit-sharing plans. The detailed records that traditional plans must maintain
to comply with the complex nondiscrimination regulations aren't required for SEPs. Also, employers aren't required to file annual
reports with IRS—Forms 5500—which, for a pension plan, could require the
services of an actuary. What record-keeping is required can be done by a
trustee of the SEP-IRAs—usually a bank or mutual fund.
Another option for a business
with 100 or fewer employees is a “savings incentive match plan for employees”
(i.e., a “simple” plan). Under a simple plan, a “simple IRA” is established for
each eligible employee, with the employer making matching contributions based
on contributions elected by participating employees under a qualified salary
reduction arrangement. The simple plan is subject to much less stringent
requirements than traditional qualified retirement plans. Or, an employer can
adopt a “simple” 401(k) plan, with similar features to a simple plan, and
automatic passage of the otherwise complex nondiscrimination test for 401(k)
plans.
Please call us if you want these
options explained in greater detail.