IRA Financial’s Adam Bergman Esq. discusses the SEP and SIMPLE IRA plans and why they are good retirement plan options for many small businesses.
Certain businesses, especially those on the smaller side, should consider the SEP or SIMPLE IRA. Each has many benefits for the small business owner looking to save for retirement. They are both cost effective and easy to implement compared to the 401(k). Further, you help entice employees and retain them better if you offer them a way to save for retirement. Of course, if you do not have any employees (other than a spouse or partner) you can utilize a Solo 401(k). That is the best plan for the self-employed. However, if you do employ workers, or your owner-only business has the need to hire on people, you can look at one of these IRA plans that are designed specifically for small businesses.
The SEP IRA
The Simplified Employee Pension (SEP) IRA is very popular for small business owners. It’s basically an employee profit sharing plan. All employees of the business who are at least age 21 and work three of the previous five are eligible to participate. Of course, if you have younger or newer employees, you do not have to offer them the plan right away. Contributions to the plan must be made for not only you and other owners, but for all eligible employees. Depending on the type of business you have, you may contribute up to 20 or 25% of each employees’ compensation for the year. Obviously, you may choose how much you wish to contribute
The caveat to the plan is that each employee gets the same percentage contributed to the plan on his or her behalf. If you want to contribute 10% to the IRA, then all eligible employees must receive the save 10% contribution. Of course, if you are a new business owner, you won’t have eligible employees until they have worked at least three years for the company. You, as the business owner, can contribute, but, since you don’t have any eligible employees for the first few years, you do not have to offer the benefits. Again, offering retirement benefits may help get you better employees.
The last thing to note is that once you choose the compensation percentage, it doesn’t have to be forever. If you were contributing 10% annually, and you have a down year, you may choose to lower that, or even not contribute to the plan during a given year. Keep in mind, this applies to all employees. It’s important to be up front about any changes to the contributions.
The SIMPLE IRA
The Savings Incentive Match PLan for Employees or SIMPLE IRA, is a less popular plan options for business owners. However, it does offer some advantages for saving for retirement. The difference is how contributions are made and who makes them. Contributions to a SIMPLE IRA can be made by the employee, dollar for dollar, and the employer also contributes. This means they are not based on a percentage of your salary. For obvious reasons, this is not a great plan for owner-only businesses. But once you have employees, this plan may work for you.
Employers can choose one of two options. First, they can make a straight two percent contribution for each employee, no matter if that employee contributes to the plan. Alternatively, the employer may contribute three percent based on what each employee contributes. So if an employee contributes three percent, you contribute an additional three percent.
Also, if you are having a down year, you can reduce the three percent to as low as one percent. However you can only do that twice during a five year period and you must tell your employees within 60 days if such a change is made.
Which Should You Choose?
A lot depends on you business and how you want to save for retirement. The SEP IRA is purely a profit sharing plan, so only you, as the employer, make contributions to the plan. Plus, you can only contribute based on a certain percentage of your salary. You must also contribute that same percentage to each of your employees.
The SIMPLE IRA has lower contribution limits, however they are made on a dollar for dollar basis. You can choose how to contribute based on what your employees do as well. Further, you may contribute less to those employees than what you, yourself, contribute. For example, if you have 25 eligible employees and you want to contribute 20% for yourself, it might not be worth it to contribute 20% to all 25 employees with a SEP IRA. Instead, you may contribute to a SIMPLE IRA to the maximum, and contribute only 2 or 3% to each employee.
The alternative to these two IRA plans is a Safe Harbor 401(k), which Mr. Bergman talks about in the podcast. They can be a little more complicated and more expensive to administer. In the end, it’s up to you to decide which plan works best for your business.
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Join us next episode as Mr. Bergman discusses the different types of investments you can make with a Self-Directed IRA, including real estate and cryptocurrencies.