Employer retirement plan options include several types of plans. An employer that meets various requirements can set up either a SEP-IRA, SIMPLE-IRA, defined contribution plan, or a defined benefit plan. The rules governing each type of plan vary and are more complex for defined contribution and defined benefit plans.
SEP-IRA
A Simplified Employee Pension (SEP-IRA) is an easy account to set up and maintain. It is a plan that can be used by any employer. The plan allows a business owner to make contributions to both his own and his employees’ retirement, without getting involved in a more complex qualified plan.
To set up the plan, a business owner needs to complete IRS Form 5305-SEP. The plan can be set up as late as the due date of the business’s return, including extensions. For calendar-year businesses, the deadline is October 15 of the next year. No annual tax filing is required for this type of plan.
Under a SEP, an employer makes contributions to a traditional individual retirement arrangement account set up by or for each eligible employee. An employer may require employees to meet any of the following requirements:
- Has reached age 21;
- Has worked for the business in at least three of the last five years, and/or
- Has received at least $550 in compensation from the company this year.
Maximum 2012 contributions cannot exceed the lesser of 25% of the employee’s compensation or $50,000. The annual compensation limit allowed to calculate contributions is $250,000.
SIMPLE-IRA
This is a plan that requires little administrative paperwork. Employers with 100 or fewer employees that do not have any other retirement plan are eligible to use this type of plan. The plan is generally set up by completing IRS Form 5304-SIMPLE or 5305-SIMPLE. The plan must be established by October 1 of the current year. An exception is allowed for new employers—the plan must be established by December 31st of the calendar year. No annual tax filing is required for this type of plan.
Under this plan, a SIMPLE IRA must be set up for each eligible employee. An eligible employee is any employee who received at least $5,000 in compensation during any two years preceding the current calendar year, and is expected to earn $5,000 this year.
The maximum annual contribution is $11,500 in 2012, per employee ($14,000 for employees age 50 or older). The employer must contribute to each employee’s account. Either the employer matches the employee contributions dollar for dollar up to 3% of compensation, or the employer contributes 2% of each eligible employee’s compensation, even if the employee does not contribute to the plan.
Defined Contribution Plans
Defined contribution plans include Profit Sharing, 401(k) plans (a type of profit sharing plan) and Money Purchase Plans. Any business may establish one or a combination of these plans. There is no generic form to establish the plans, and the expertise of a financial institution or employee benefit adviser generally is required. The plan must be written and adopted by the last day of that year (December 31st for calendar-year employers). IRS Form 5500 may need to be filed annually for each of these plans.
Profit Sharing Plans
This is one of the most flexible of all retirement plans. Contributions are discretionary, meaning a company can raise, lower or eliminate contributions as profits dictate from year to year.
401(k) Retirement Plan
A type of profit sharing plan, the 401(k) is one of the least restrictive retirement savings programs available today. It permits employees to deduct a portion of their earnings before taxes. The money is allowed to grow and compound tax-deferred until withdrawn, typically, at retirement.
Money Purchase Plan
A Money Purchase Plan allows a company to make annual contributions that are not tied to profits. In many ways it operates like a profit sharing plan, except the company is required to contribute the same percentage of employees’ salaries each year.
Additional features of each plan are presented in the table below.
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401(k)
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Profit Sharing
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Money Purchase Plan
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Funding Responsibility |
Employee salary reduction contributions and employer contributions.
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Employer contributions only, unless 401(k) feature is included.
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Employer contributions only.
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Contributor’s Options
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Employee makes contributions as set by plan option. The employer may match.
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Employer makes contributions as set by plan terms. Level of contributions can be redetermined each year.
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Employer makes contributions as set by plan terms. The contributions are mandatory
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Maximum Annual Contribution Per Participant
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Employee: Up to $17,000 (additional $5,500 if participant is age 50 or older).
Employer/Employee Combined: Up to a maximum of 100% of compensation or a maximum of $50,000. |
The lesser of 25% of compensation or $50,000.
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Up to a maximum of 25% of compensation or $50,000, whichever is less
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Defined Benefit Plan
A defined benefit plan is a plan that promises a specified annual benefit that is predetermined by a formula based on the employee’s earnings history, tenure of service and age, rather than depending on investment returns. The risk is borne by the employer. In addition to being the most costly type of retirement plan, it is the most administratively complex. However, it also gives the best opportunity to put significantly more money away, even in a short amount of time, as compared to the previously discussed plans. We will not address contributions here, since annual contribution amounts are determined by a number of factors including salary, loss of value in the plan, and limits set by the IRS. Your plan administrator will have these complex calculations done for you.
If you would like any further information on this topic, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
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