SEP-IRA
A SEP-IRA is a Simplified Employee Pension plan that offers retirement savings benefits for employers and their employees. The funding of a SEP-IRA is entirely provided by employer contributions. Therefore employees do not contribute to their own accounts. For 2011, the maximum contribution per employee is limited to 25% of eligible compensation subject to an annual contribution cap of $49,000. Benefits of establishing a SEP-IRA include the following:
- Contributions to owner and employee accounts are generally tax deductible to the business;
- Contributions are fully discretionary; therefore, the annual percentage contribution can change each year, or the business can choose not to make a contribution at all;
- A SEP-IRA is inexpensive to establish and maintain. Additionally, there are no annual IRS filings, and
- Other retirement plans, such as Traditional IRAs and 401(k) plans, can be rolled over into a SEP-IRA.
Safe Harbor 401(k) Plan
A Safe Harbor 401(k) plan is a qualified retirement plan that is designed to meet non-discrimination requirements in a more simplified manner than a regular 401(k) plan. Because testing for non-discrimination in a 401(k) plan can come at a significant cost to an employer, Safe Harbor 401(k) plans are a popular choice for small-business owners. The funding of a Safe Harbor 401(k) plan comes from employee salary deferrals and employer matching contributions.
To be eligible for safe harbor treatment, the employer must elect a matching contribution formula of 100% of elective deferrals up to 3% of compensation and 50% of elective deferrals on the next 2% of compensation; or, the employer may elect the non-elective formula of a minimum of 3% of compensation contributed to all eligible participants whether making salary deferrals or not.
Which is Better?
To compare whether a SEP-IRA or Safe Harbor 401(k) plan is better for a small-business owner, consider the following example:
Assume XYZ Company has a single owner and four employees. The owner earns a $100,000 annual salary, while each employee earns a $25,000 salary.
Under a SEP-IRA, the owner can contribute a maximum of 25% of salary to his account. Should he elect to contribute at the 25% level, he must also contribute 25% of each employee’s salary to their respective SEP-IRA accounts. The total of all employer contributions would be $50,000, of which 50% (or $25,000) is contributed to the employees.
Under a Safe Harbor 401(k) plan, the owner can contribute a maximum of $16,500 in 2011, assuming he is under 50 years of age. Since his contribution is more than 5% of his salary, he can fully match his 401(k) at 4% of salary (100% match on the first 3% of contributions, and 50% match on the next 2% of contributions). Assuming the employees contribute at the 5% level, the owner would have to match $1,000 of each employee’s contributions. The total of all employer contributions would be $24,500, of which 16% (or $4,000) is contributed to the employees.
|
Compensation
|
SEP-IRA
Maximum 25% Contribution |
Safe Harbor 401(k) Contribution
|
Safe Harbor 401(k) Match
|
Total 401(k) Owner Contribution
|
|
|
Owner
|
$100,000
|
$25,000
|
$16,500
|
$4,000
|
$20,500
|
|
Employee No. 1
|
$25,000
|
$6,250
|
$1,250
|
$1,000
|
$1,000
|
|
Employee No. 2
|
$25,000
|
$6,250
|
$1,250
|
$1,000
|
$1,000
|
|
Employee No. 3
|
$25,000
|
$6,250
|
$1,250
|
$1,000
|
$1,000
|
|
Employee No. 4
|
$25,000
|
$6,250
|
$1,250
|
$1,000
|
$1,000
|
Bottom Line
Under the SEP-IRA, the employer was able to defer $25,000 of his own salary at the cost of contributing $25,000 to the employees. Under the Safe Harbor 401(k) plan, the employer was able to defer $20,500 of his own salary, which is less than under the SEP-IRA scenario. However, the cost to him was significantly less, since he only had to contribute $4,000 to the employees. Assuming the costs of implementing the Safe Harbor 401(k) plan are not significantly higher than a SEP-IRA, the safe harbor option appears to be a more effective retirement savings vehicle for the owner. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or at experts@henssler.com