The creation of the Simplified Employee Pension (SEP) and the Savings Incentive Match Plan for Employees (SIMPLE) affords smaller businesses with a way to offer their employees and/or and themselves a retirement plan. The SEP and SIMPLE were designed for businesses with less than 100 employees and are less costly to administer than a 401(k). For the employees, they are both easy to understand and provide a convenient way to save for retirement.
As qualified retirement plans, SEP IRA's and SIMPLE IRA's enjoy the same tax treatment as other plans. Contributions by employees and employers are tax deductible or made on a pre-tax basis. The accumulation inside the accounts grows tax deferred. The many of the same restrictions apply as well. Withdrawals made prior to age 59 ½ may be subject to a penalty.
As with all defined contribution plans, the future retirement benefit is uncertain as it depends on the amount of contributions, how long they accumulate, and the rate of return on the account over that period of time. At the time of distribution, withdrawals are taxed as ordinary income with no allowance for 10-year averaging as is available through a 401(k).
Simplified Employee Pension (SEP)
A SEP is easy to setup even easier to administer. Each employee established their own SEP-IRA to which the employer contributions are made. Although the employer is not required to make a contribution each year, when one is made it must be contributed to all employees over the age of 21, part-time included, based on 25% of covered compensation up to $69000(2024).
The employees manage their own SEP-IRAs which can be invested in mutual funds, money market funds, or fixed investments. The funds are always 100% vested so they can be accessed immediately by the employee (subject to an early withdrawal penalty). Employees with SEP-IRAs can also invest in their own traditional or Roth IRA subject to some income limitations.
For employers, their only responsibility is to make the contribution by their tax filing deadline. There is no administration of the accounts and there is no forfeiture provision to manage.
SIMPLE IRA
In a SIMPLE IRA Plan, employees establish their own IRA to which they can electively make tax deductible contributions. Employees who earn at least $5,000 during any two prior years as well as the current year are eligible to participate on a voluntary basis. The maximum amount that can be contributed is $16000 (+$3500 catch up age 50+) or 100% of their compensation whichever is less.
Employee funds are 100% vested, however, in addition to the normal early withdrawal penalty of 10%, if a withdrawal is made within the first two years of participation, the penalty is 25% unless any exceptions apply.
The employer must match the employee’s contributions up to 3% of their elective deferral, or 2% of all compensation for all employees whether they defer or not.
There is another version of a SIMPLE called the 401(k) version which is structured much like the IRA version. The advantage of the 401(k) version to the employer is that it can establish stricter requirements for plan eligibility which could reduce the amount of matching contributions. The disadvantage is that the same ERISA reporting rules apply to a SIMPLE 401(k) as they do the regular 401(k), so it can be more costly to administer.
Solo 401(k)
A self-employed 401(k)—sometimes called a solo-401(k) or an individual 401(k)—is a type of savings option for small-business owners who don't have any employees (apart from a spouse). That makes these accounts a good fit for sole proprietors, independent consultants, partnerships, and owner-only corporations looking for a retirement plan similar to one they might get from working at a larger company.
In many ways, the self-employed 401(k) works the same way as a standard 401(k). You as the employer, make contributions on your behalf as the employee from your pre-tax earnings, and you can also make contribution as the employer. Those contributions can be combined to invest in a range of vehicles to grow tax-deferred until withdrawn in retirement.
The highlight of the self-employed 401 (k) is the ability to contribute to the plan in two ways. According to 2024 IRS 401(k) and Profit-Sharing Plan Contribution Limits, as an employee, you can make salary deferral contributions equal to the lesser of $23,000, or 100% of your compensation. If you're at least 50 years old or will turn 50 years old in 2024, your savings options are even higher because you can add an extra $7,500 in catch-up contributions each year. Then, as the employer, you can make a contribution of up to 25% of your compensation each year.
Total contributions to a participant’s account, including catch-up contributions for those age 50 and over, cannot exceed $76500 for 2024. For those under 50, total contributions cannot exceed $69,000.
Together, those contributions can add up to significant annual savings. For example, if you're an independent consultant under 50 (with no employees) with 2024 compensation of $100,000, you could elect to defer up to $22,500. Then, as the employer, you could contribute $25,000 more based on your compensation minus business expenses and self-employment taxes. In total, you could set aside $47,500 in one year to help build your retirement nest egg.
Self-employed 401(k) contributions may also make you eligible for added tax breaks. If your business is not incorporated, you can generally deduct contributions for yourself from your personal income. If your business is incorporated, you can count the contributions as a business expense.
For additional information on small business retirement plans, contact us today.