Retirement Plan Choices for a Growing Small Business

When we save for retirement, most of us take advantage of one or both of the two most common types of retirement plans—personal and employer-sponsored. Personal retirement plans include Individual Retirement Accounts (IRAs), personally-owned annuities and CDs, and other savings vehicles into which we make personal after- or before-tax contributions. Employer-sponsored retirement plans include 401(k)s, profit-sharing plans and other programs into which both we and our employers (or possibly only our employers) contribute.

But there are two other types of employer-sponsored plans that those of us who are self-employed or who own and operate a small business might find equally or even more attractive, primarily because of their flexibility and generous contribution limits. They are simpler to operate than traditional employer-sponsored plans and they offer greater tax benefits than personal IRAs. They are well-suited to many different types of enterprises, including “start-up” businesses that are just getting off the ground. And they are easy to set up and run.

SEPs and SIMPLEs: A Comparison

The two plans about which we are talking are called Simplified Employee Pension plans (SEPs) and Savings Incentive Match Plans for Employees (SIMPLEs).

SEPs and SIMPLEs have four main features in common:

1. They are funded with pre-tax dollars and allow tax-deferred earnings.
2. All contributions are made directly into IRAs in each participant’s name, and all assets are immediately vested.
3. Both plans allow business owners to set aside more money for their own retirements than is allowed under a personal IRA.
4. Both plans are easy to operate. They avoid most if not all of the administrative and reporting complexities of 401(k)s and other types of retirement plans.

In both SEPs and SIMPLEs, participants can allocate their contributions among a variety of investment options. Contributions are generally made on a tax-deductible basis, and earnings grow income tax-deferred. Like traditional retirement plans, a 10 percent federal tax penalty applies on withdrawals made prior to age 59 ½.[1] (Note: a 25 percent penalty will be assessed on withdrawals made from a SIMPLE plan prior to age 59 ½ during the first two years of the plan).

Which plan is right for you?

Congress created the Savings Incentive Match Plan for Employees (SIMPLE) to provide small-business owners and professionals with a practical alternative to 401(k) plans. TheSIMPLE IRA allows small-business owners and professionals to offer a company-sponsored retirement plan without all the administrative responsibilities and expenses associated with traditional 401(k) plans.

In order to qualify for a SIMPLE IRA plan, a business must meet two basic criteria: first, it must have 100 or fewer employees (who earned $5,000 or more during the preceding calendar year); and second, it cannot currently offer another retirement plan.

A SIMPLE IRA plan provides business owners and employees with a simplified way to contribute toward retirement. It reduces income taxes and, at the same time, can help businesses attract and retain quality employees. And compared to other types of retirement plans, SIMPLE IRA plans offer lower start-up and annual costs.

Advantages of a SIMPLE IRA:

• SIMPLE IRA plans are easy to set up and run – your financial institution handles most of the details.
• Employees can contribute, on a tax-deferred basis through convenient payroll deductions.
• Liberal employee contribution limits (In 2010, any eligible employee may contribute 100 percent of pay up to $11,500. Employees age 50 or older may contribute an additional $2,500.)
• The business can choose either to match the employee contributions of those who decide to participate (100 percent match up to the first three percent of income) or contribute a fixed percentage (two percent) of all eligible employees’ pay.
• Administrative costs are low.
• The business is not required to file annual financial reports.

Simplified Employee Pension plans (SEPs) can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. Under a SEP, an employer contributes directly to a traditional individual retirement account (SEP-IRAs) for each employee (including him or herself).

SEPs allow employers to set aside significantly greater amounts of money than both traditional IRAs and other employer-sponsored plans. For self employed individuals, this can be a tremendous advantage.

Advantages of a SEP:

• Contributions are income tax deductible and earnings accumulate within the plan income tax deferred.
• Contributions do not have to be made every year. The business decides each year whether and/or how much to contribute based on its financial situation.
• Liberal contribution limits. For 2010, 25 percent of an employee’s wages (or up to 20 percent of Schedule C income) may be contributed up to a maximum of $49,000.
• There are generally no documents to file with the IRS.
• Sole proprietors, partnerships, and corporations, including S corporations, can set up SEPs.
• Administrative costs are low.

If you are interested in starting a retirement plan, it’s a good idea to ask a financial professional to help you compare the benefits of each choice in light of your personal and business goals. You may have more control over your retirement than you think!

This presentation has been prepared based on Penn Mutual’s current understanding of tax laws. Any changes in these laws may result in a conclusion different than what is represented.

1 *Unless an approved IRS exception applies. See Publication 560 at www.irs.gov.