Simple retirement savings options for your small business

Are you thinking about setting up a retirement plan for yourself and your employees, but you’re worried about the financial commitment and administrative burdens involved in providing a traditional pension plan? Two options to consider are a “simplified employee pension” (SEP) or a “savings incentive match plan for employees” (SIMPLE).

SEPs are intended as an alternative to “qualified” retirement plans, particularly for small businesses. The relative ease of administration and the discretion that you, as the employer, are permitted in deciding whether or not to make annual contributions, are features that are appealing.

Uncomplicated paperwork

If you don’t already have a qualified retirement plan, you can set up a SEP simply by using the IRS model SEP, Form 5305-SEP. By adopting and implementing this model SEP, which doesn’t have to be filed with the IRS, you’ll have satisfied the SEP requirements. This means that as the employer, you’ll get a current income tax deduction for contributions you make on behalf of your employees. Your employees won’t be taxed when the contributions are made but will be taxed later when distributions are made, usually at retirement. Depending on your needs, an individually-designed SEP — instead of the model SEP — may be appropriate for you.

When you set up a SEP for yourself and your employees, you’ll make deductible contributions to each employee’s IRA, called a SEP-IRA, which must be IRS-approved. The maximum amount of deductible contributions that you can make to an employee’s SEP-IRA, and that he or she can exclude from income, is the lesser of: 25% of compensation and $58,000 for 2021. The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA. Your employees control their individual IRAs and IRA investments, the earnings on which are tax-free.

There are other requirements you’ll have to meet to be eligible to set up a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of the highly compensated employees. But these requirements are minor compared to the bookkeeping and other administrative burdens connected with traditional qualified pension and profit-sharing plans.

The detailed records that traditional plans must maintain to comply with the complex nondiscrimination regulations aren’t required for SEPs. And employers aren’t required to file annual reports with IRS, which, for a pension plan, could require the services of an actuary. The required recordkeeping can be done by a trustee of the SEP-IRAs — usually a bank or mutual fund. 

SIMPLE Plans

Another option for a business with 100 or fewer employees is a “savings incentive match plan for employees” (SIMPLE). Under these plans, a “SIMPLE IRA” is established for each eligible employee, with the employer making matching contributions based on contributions elected by participating employees under a qualified salary reduction arrangement. The SIMPLE plan is also subject to much less stringent requirements than traditional qualified retirement plans. Or, an employer can adopt a “simple” 401(k) plan, with similar features to a SIMPLE plan, and automatic passage of the otherwise complex nondiscrimination test for 401(k) plans.

For 2021, SIMPLE deferrals are up to $13,500 plus an additional $3,000 catch-up contributions for employees age 50 and older.

Contact us for more information or to discuss any other aspect of your retirement planning.

© 2021

Is a Roth Conversion Right For You?

Roth IRAs offer many benefits, including federal income tax-free withdrawals, provided you follow the rules. You can convert a traditional IRA to a more flexible Roth IRA, but it will trigger a significant taxable event.

TAXES

Because contributions to a traditional IRA are tax deductible and earnings are tax deferred, you’ll have to pay income taxes on all the funds you transfer in the year you execute the conversion. In a perfect world, you would pay taxes out of pocket, leaving more in your Roth IRA to continue to grow—income tax-free.

SOME DIFFERENCES

Traditional IRAs have required minimum distributions (RMDs) — and paying income taxes on those RMDs — every year after you reach age 72, (age 70½ if you attained age 70½ before 2020).* You have to take RMDs and pay the taxes even if you don’t need the money.

Roth IRAs have no RMD requirement. In general, you can withdraw earnings without penalties or federal taxes as long as you’re 59½ or older and you’ve owned the account for at least five years. (Some exceptions apply.)

WHO SHOULD CONSIDER CONVERTING TO A ROTH IRA?

A Roth IRA may be right for you if:

  • You believe your tax rates will be higher in the future;
  • Your income may be lower than usual this year;
  • Your IRA account value is lower this year, due to the pandemic;
  • You don’t need the money to live on for at least five years;
  • You want to leave the money to your heirs;
  • You are concerned about estate taxes.

WHO SHOULD NOT CONVERT?

A Roth conversion may not be the best strategy if:

  • You will need the money within five years;
  • You’re in a higher tax bracket now than you expect to be in retirement.

Consult your tax and financial professionals before taking action.

*The CARES Act suspended RMDs for 2020.