Choosing a retirement plan can be a confusing and expensive process for small business owners.
There are many retirement plans available, and the key is finding the right fit for the size and scope of your business.
Last week I discussed the option of setting up a SEP IRA to provide retirement plans for yourself and your employees through your small business. Because employees are not allowed to make contributions to the SEP IRA, it can be a very expensive route. Usually it’s the sole proprietor or partner in a partnership in which there are no employees who opt for a SEP IRA.
Other small businesses may decide that a SIMPLE plan is the best device for securing retirement benefits for themselves and their employees.
A SIMPLE plan is available to any small business – usually with 100 or fewer employees. It’s a matter of filing Form 5304-SIMPLE, or 5305-SIMPLE. According to Brett Goldstein, a financial advisor with American Investment Advisors of Jericho, N.Y., “Overall, SIMPLEs have become very popular due to their simplicity. Financial advisors sell them on the basis of no administration fees, no hassles, and no complicated rules.”
But he also warns that many financial advisors don’t tell clients about the drawbacks of SIMPLE Plans.
“[They] can’t be terminated in the middle of the year. Once you start the plan in January you are stuck with the plan until December. If a business is struggling financially, they must keep the SIMPLE IRA plan for the entire year and make all of the matching contributions - despite their financial troubles. 401k plans are much more beneficial and flexible despite the extra paperwork and their costs.”
After the plan is set up there is no annual filing requirement like there is with other retirement plans. If a SIMPLE plan is established, the business is not allowed to have any other retirement plans in place.
Unlike the SEP IRA, employees are allowed to make contributions to a SIMPLE plan. In fact, it is set up so that employers aren’t required to make a matching contribution unless the employee does so as well. However, the employer can elect to have a 2% nonelective contribution for each participating employee. This means that even if the employee does not make a contribution, the employer must still make one on the employee’s behalf up to 2% of that employee’s compensation. But this is simply an election that can be made.
Otherwise, the employer may make matching contributions up to 3% of employee compensation per year. You are allowed to change the percentage of matching contribution from one year to the next but you cannot go below 1% and you can make this change for no more than 2 out of 5 years. It is therefore important that your business be profitable and well-established if you are to take on the responsibility of providing this type of retirement plan.
The employee contributions made into the plan are with pre-tax dollars. At year end, the employee does not take a deduction for the IRA contribution as an adjustment to income on page 1 of Form 1040 like one would do for a traditional IRA. Instead, the amount is included as a reduction to salary on Form W2. The deduction is built-in.
If permitted by the SIMPLE IRA plan, participants who are age 50 or over at the end of the calendar year can also make catch-up contributions. The catch-up contribution limit for SIMPLE IRA plans for 2012 and 2013 is $2,500.
So let’s say your employee Mandy makes $50,000 per year. She decides that she wants to contribute 5% ($2,500) of her salary to the plan. The employer must match up to 3% or $1,500 for a grand total of $4,000. The maximum employee contribution to the plan for 2013 tax year is $12,000. The contribution limits change from year to year so check with your plan administrator or your tax professional.
Vesting in the plan is automatic. Your employee always owns 100% of all SIMPLE IRA money is his or her plan.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, Calif., and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Her new e-book Taxpertise for the Creative Mind Murder, Mayem, Romance, Comedy and Tax Tips for Artists of all Kinds is available at all major booksellers. Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.