Self-Employment Retirement Plans - The Choice is Yours

Anthony J. Finochio (Jul, 2017)

As a business owner, you find yourself making important decisions everyday about how to best operate and run your business.  You may spend countless hours in meetings with both customers and clients, as well as your executive team, to determine the next course of action for the business.  While the operation of your business should be your primary focus, an important decision has to be made as to how best to fund your retirement and whether or not the company will fund a portion of the employees' retirement. 

Two options for a small business owner in planning for retirement are the SEP (Simplified Employee Pension) and SIMPLE (Savings Incentive Match Plan) IRAs.  There are several similarities between the SEP and SIMPLE, but their differences will help to determine which one is right for your company.

A SEP is a written arrangement which allows you, the employer, to make contributions towards your and your employees' retirement.  With a SEP, contributions are made to a traditional individual retirement account (IRA) for each eligible employee.  Once an account is setup for an employee, it is owned and controlled by them.  Typically, to be an eligible employee the individual is usually at least 21 years old, worked for the company in the last 3 out of 5 years, and earned a minimum of $600 in compensation for the year.  However, the company can establish eligibility requirements that are less restrictive than this if they want more employees to become eligible.      

The rules for SEP plans allow employers to contribute a limited amount of money to each employee's SEP each year.  Contributions are discretionary, so there is no obligation to fund in a given year.  Contributions to this plan are always 100% vested.    

If you do decide to make a contribution, they must be based on a written allocation formula and not discriminate in favor of highly compensated individuals.  In addition, contributions must be made to all eligible participants who were actively employed during the year.  These participants include employees who have passed away, or were separated from employment, before the contributions were made. 

Contributions made in 2017 to an eligible employee's SEP cannot exceed the lesser of 25% of their compensation, or $54,000 (up from $53,000 in 2016), with a maximum compensation of $270,000 considered.  Contributions to your and your employees' SEP retirement accounts are tax deductible as long as these limits are not exceeded.

A SIMPLE IRA plan is another retirement option for small employers.  With this type of plan, unlike the SEP, the employee may defer up to $12,500 of their compensation each year.  Employees who are age 50 or over can make an additional catch-up contribution of up to $3,000. 

To be eligible, all employees who received at least $5,000 in compensation during any two preceding calendar years (whether or not consecutive), and who are reasonably expected to receive at least $5,000 in compensation during the calendar year, may participate in the SIMPLE IRA plan for the calendar year.  Again, the employer may opt for less restrictive eligibility requirements. 

Under a SIMPLE IRA plan the employer must make an annual contribution.  When the plan is set up the employer chooses between either making a matching contribution for all those employees that contribute, or providing a non-elective contribution to all eligible employees.  If an employer match is made, the employer matches each employee's salary deferral contribution on a dollar-for-dollar basis, up to a maximum 3% of the employee's compensation.  If contributing for all eligible employees, the employer must commit to funding 2% of an employee's compensation up to the annual limit of $270,000.  Any allowable contributions made by employers on the behalf of their employees are tax deductible.       

Regardless of the type of business you have, you will most likely benefit from implementing a SIMPLE IRA or SEP IRA plan.  Each will provide a deductible expense that will help you lower your taxes while providing a valuable benefit to your employees.  Before deciding on a plan, it is important to take into consideration all factors about your business.  By looking at future goals, only then will you be able to decide which plan is right for you. 

Should you have any questions about your plan, or would like information on establishing a new retirement plan, please contact Dermody, Burke, and Brown to discuss with your trusted tax adviser.  


The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.

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