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Retirement Plans For Small Business

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Retirement Plans For Small Business

Simplified Employee Pension

SEP is a written arrangement (a plan) that allows an employer to make contributions toward his/her own retirement (if a self employed individual) and his/her employees retirement, without becoming involved in more complex retirement plans.
Contributions are made to the IRAs (SEP-IRAs) of the participants in the plan (Form 5498).
IRAs are set up for, at a minimum, each qualifying employee and/or self-employed individual.
Employer must make the contributions to that plan by the due date of the employer’s return, including extensions.
SE individual is an employee for SEP purposes, he is also the employer. Even if he is the only individual he can have the SEP-IRA.
Qualifying employee is one who meets all of the following conditions:-
Is at least 21 years old.
He has worked for the employer during at least 3 of the 5 years immediately preceding the tax year,
He has received from the employer at least $500 in compensation in the tax year.
Following groups of employees can be excluded:-
Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by their union and their employer.
Nonresident alien employees who have no U.S. source earned income from their employer.
Does not require contributions every year, but it must not discriminate in favor of highly compensated employees

Savings Incentive Match Plans For Employees (SIMPLE)

Employers with 100 or fewer employees who received at least $5,000 in compensation from the employer in the preceding year are eligible
Employer cannot maintain another qualified plan
Employees can make elective contributions of up to $10,500 ($13,000 if 50 or older) and requires employers to make matching contributions.
Not subject to nondiscrimination rules or other complex requirements applicable to qualified plans.
SIMPLE plans may be structured as an IRA or as a 401k qualified cash or deferred compensation
Required match of 3% of compensation (employer may elect a lower limit of at least 1% in any 2 of 5 years) or non-elective contribution for all employees of 2% of compensation. $230,000 compensation limit applies only for non elective contributions of 2% Self-employed individuals may participate in a SIMPLE plan
Employer Contributions are expressed as a percentage of compensation, must make contribution even in lean years of at least 1% of employee compensation.
Employer must make the elective deferral to the employee’s SIMPLE account no later than 30 days after the last day of the month.
Employer must make matching contributions by the due date of the tax return including extensions.
Matching deductions are deductible for the year only if made by the due date of the tax return, including extensions.
Distributions are taxed like distributions from an IRA, unless rolled over from one SIMPLE account to another account or rolled over to an IRA after 2 years or rolled over to a qualified plan after 2 years.
Withdrawals before age 59-1/2 are subject to 10% tax, withdrawals within the first 2 years are subject to a 25% penalty, distributions from a SIMPLE account are includible in a participants income when withdrawn.
Employee’s elective contributions will be treated as wages for purposes of employment tax, employer’s matching or non-elective contributions are not wages.

Keogh Plans

Qualified employer plan set up by a self-employed person is sometimes called a Keogh Plan or HR10 Plans
Only a Sole proprietor or a partnership may set up a Keogh Plan, must be set up by year end.
2 Types of Keogh Plan are defined-benefit and defined contribution
In a defined-contribution plan, a fixed contribution (percentage of total paycheck or a fixed sum) is made per pay period.
There are two types of defined contribution plans:-
Profit-sharing Plan (based on the employer’s profits)
Money Purchase Pension Plan ( based on a fixed amount and not profits)
Contribution under the defined-contribution plan cannot exceed the lesser of
100% of the employee’s compensation or
The defined-benefits plan is more complex. It relies on an IRS formula to calculate the rate of contributions. It may be set up as a profit-sharing plan, where the pension that one can withdraw after retirement depends on how much they invest in the plan while they worked.
Contribution under the defined-benefit plan cannot exceed the lesser of
100% of the participant’s average compensation for hi/her highest 3 consecutive calendar years or
In either case, as in other retirement plans, the funds in the plan can be invested in stocks, bonds, mutual funds, etc.
Employees can generally contribute up to $16,500 per year, and the employer can contribute up to $38,500, for a total annual contribution of $49,000
Keogh Plans cannot be used for “self-employed” individuals who work in the capacity of an independent contractor. Keogh Plans are applicable to self-employed individuals who own their own business (with articles of incorporation, etc.).
Businesses with more than 10 employees are not eligible for Keogh Plans
All contributions must be made “pre-tax,” meaning that the contributions can be deducted from this year’s tax, but taxes must be paid on the money when it is withdrawn during retirement. There is no such thing as a “Roth Keogh Plan.”
10% additional tax may apply for making withdrawals from a Keogh Plan before you turn 59 1/2, there are exceptions available in certain cases.


The main benefit of a Keogh Plan vs. other plans (Keogh’s high contribution limit) is lost in individuals who do not make a high level of income. These individuals may get the same benefits of a Keogh Plan with less administrative cost by using another type of retirement plan (401k, SEP-IRA, etc.) This is best illustrated by comparing the following 3 scenarios:

Scenario #1 – A self-employed accountant makes $50,000 per year from her accounting business. Her maximum contribution is 25% of her post-contribution income ($10,000, which would be the same as saying 20% of her gross income), regardless of whether she uses a SEP-IRA, Keogh Plan, or SIMPLE 401(k). Since there are less administrative costs, she would benefit most from choosing either the SEP-IRA or SIMPLE 401(k).

Scenario #2 – A family physician who owns his own practice makes $100,000 per year. His maximum contribution is 25% of his post-contribution income ($20,000, which would be the same as saying 20% of his gross income) whether he uses a Keogh Plan or a SEP-IRA. The cost of maintaining the SEP-IRA is much less, so he would benefit more from that plan.

Scenario #3 – An entrepreneur who owns a small marketing firm makes $400,000 per year. She wishes to contribute as much as possible to a retirement plan in order to minimize her current taxes. She could contribute up to $11,500 for a SIMPLE IRA, $49,000 to a SEP-IRA, up to or up to $65,500 in a Keogh Plan. By choosing the Keogh Plan over the SEP-IRA, she can contribute an additional $16,500 per year into her retirement plan. She can also contribute $5,000 into a traditional IRA. Based on a marginal tax rate of 33%, these contributions save her a total of $7,095 in taxes for the year.


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