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
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
