Many people are familiar with pension plans, defined benefits, defined contributions and 401K or 403B plans. However for small employers, what is often overlooked are two very attractive alternatives to the aforementioned ways of deferring income for the owner and employees. These two are known as Simplified Employee Pension (SEP) plan and Savings Incentive Match Plan for Employees (SIMPLE) IRA plan. Let me endeavor to explain the differences and advantages of each.
With a SEP plan, a small employer can defer up to 20% of their 2013 income to a maximum compensation of $255,000. This is a very lucrative way to defer taxation on income for small employers. It is more than you can usually contribute to a 401K, however there is a drawback.
The drawback is every single employee who meets certain criteria must be covered. That criteria being a thousand hours a year of employment and having worked for you for at least 3 years. In the event that the small employer has a few employees, this can become expensive. For example, if there is a group of eligible employees that make $300,000, the employer while deferring $51,000 for themselves, would also have to contribute $60,000 for the employees which may or may not be what the employer wanted to do. But for employers with no other employees or only a few employees this can be very lucrative.
The SIMPLE IRA plan is the other very, very lucrative option for small employers. Unfortunately, it’s a plan that has very little visibility; a lot of the people I’ve talked to have never heard of it. A SIMPLE IRA plan works similar to a 401K. It allows the individuals, including the business owner, to defer on an annual basis, up to $12,000 ($14,500 for those employees and employers who are fifty or over) from their salaries.
On top of that, the employer can match up to 3% of the amount of employee compensation. Unlike a SEP plan, where an employer must contribute for everyone, here an employer has to contribute only for those who partake of the plan and take deferrals. For instance, if a few employees deduct 3% or more from their pay, the employer must match the 3%. However, any employees who decide not to deduct, the employer does not have to match; and in the case where an employee decides to deduct 1% or 2%, that is all the employer must match. So while the employer in this position won’t be able to put away as much as with a SEP plan, he also will not have the burden of having to put away as much money for all of the employees.
These two types of plans are easy to form, require no filing of government forms, and do not require you to have an administrator who has to file pension reporting (5500) forms. Once alerted to these options, I have found that many of my smaller employers prefer these plans tremendously over 401K or 403B, etc. plans.