SEP Plan & Simple IRA Limitations
Retirement plans available to small businesses include SEP plans and Simple IRAs. Implementing a SEP plan or Simple IRA will benefit both employer and employee. An employer can deduct the contributions it makes to the established plan on behalf of its employees from its taxes. Eligible employees will enjoy tax-deferred growth on their retirement savings. SEP plans and Simple IRAs include limitations applicable to both employers and employees.
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Similarities
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SEP plans and Simple IRAs are non-qualified, employer-sponsored retirement plans. Either plan may be established by a business regardless of the company's legal structure. Compared to qualified plans, SEPs and Simple IRAs can be set up at little cost and require minimal administration. In an effort to help businesses recoup the cost of establishing these plans, the IRS allows employers to deduct up to $500 of the set up fees during each of the first three years the plans are in place.
SEPs and Simple IRA plans assign an individual retirement account to each employee eligible to participate in the retirement plan. Employers may make contributions on behalf of employees and deduct their contributions from the business' taxes. Contributions earn tax-deferred interest.
Employer contribution limits are determined by the IRS. The IRS reviews these limits regularly and makes adjustments for increases in the cost of living when considered appropriate.
Withdrawals from SEPs and Simple IRAs are governed by the same rules the IRS applies to distributions from traditional IRAs.
SEP Plans
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The abbreviation SEP translates into Simplified Employee Pension Plan. A SEP plan does not require an employer to make contributions on behalf of its employees; employer contributions are made at the discretion of the business and are deposited into each employee's retirement account. Contributions are 100 percent vested, meaning they belong to the employees in their entirety, at the time of deposit.
If an employer chooses to make contributions to the IRA accounts of its employees, the contributions must be made in amounts equal to the same percentage of each eligible employee's pay. For example, if John's employer opts to make a 3 percent SEP contribution on behalf of its employees and John makes $100 per year, $3 would be deposited into his SEP IRA by his employer. If John's coworker makes $300 annually, the employer would deposit $9 into that employee's SEP IRA.
SEP plans do not allow employees to make tax-deductible contributions to their retirement accounts.
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SEP Plan Limitations
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Establishing an SEP empowers an employer to define what makes an employee eligible for participation in the plan within limits. An employer can lower, but not exceed, the following IRS standards for employee eligibility: minimum age of 21 and income from the employer in three of the five years prior to the plan's implementation. An employer does not have to allow employees who earned less than $550 during a year, non-resident aliens or employees covered by a union contract to participate in a SEP, but may choose to permit their participation.
In 2011, an employer may contribute the lesser of $49,000 or 25 percent of an employee's compensation into an employee's retirement account, assuming the employee does not participate in any other retirement plan. Employer contributions to a SEP may be deducted from the business' taxes but cannot exceed 25 percent of the total compensation paid to all employees.
Simple IRA
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The title "Simple" is an acronym for savings incentive match plan for employees. A Simple IRA requires employers to make contributions to their employees' retirement accounts every year. Unlike SEPs, Simple IRAs give employees the option to reduce their taxable salaries by making contributions to their accounts.
An employer can make either a non-elective or matching contribution to the retirement accounts of its employees. If an employer opts to make a non-elective contribution, every employee must receive an IRA contribution of 2 percent of his compensation from his employer regardless of whether the employee has chosen to contribute to his own account.
If an employer chooses to make a matching contribution to the retirement accounts of its employees, the employer must contribute to the accounts of only those employees who have chosen to make salary-deferred contributions of their own. An employer's matching contribution may equal up to 3 percent of an employee's annual pay. The matching contribution may also be as low as 1 percent of an employee's compensation in any two years of a five-year period.
Simple IRA Limitations
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Simple IRAs may be implemented by organizations that employed fewer than 100 individuals earning more than $5,000 in the previous year. To start a Simple IRA plan, an employer cannot have any other retirement savings vehicle in place.
Employers can limit employee participation in Simple IRA plans by including a minimum compensation requirement of $5,000 during the previous two years in the plan's eligibility requirements when the plan is created. Alternatively, an employer may elect to allow all of its employees to participate in the Simple IRA plan.
In 2011, an individual employee may defer up to $11,500 of his salary into a Simple IRA. If an employee is at least 50 years old, he may defer an additional $2,500 into the account in accordance with the IRS' "catch-up" provision.
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References
- Know Your Simple IRA Plan Limits?; Alyssa Holden; October 2010
- Retirementdictionary.com: Simple IRA: Savings incentive match plan for employees of small employers
- SEP IRAs: A low cost retirement plan for small business; Denise Appleby; March 2011
- Internal Revenue Service: Retirement Plans FAQs regarding SIMPLE IRA Plans
- Internal Revenue Service: Publication 560 Retirement Plans for Small Business
- U.S. Department of Labor: Simple IRA Plans for Small Businesses
Resources
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