Retirement Plans for Small Businesses

As a small business owner, it's never too early to learn about the retirement plans that are available. Some will meet your needs, some will not. Your needs may also change as your business grows.

Below are three plans that can be set up by any small business owner:

• Simplified Employee Pension Plan (SEP)
• SIMPLE Plan, AND
• Keogh Plan (also called H.R. 10 plan)

SEP, SIMPLE, and Keogh Plans offer you and your employees a tax favored way to save for retirement. If up a retirement plan, you can deduct contributions you make to the plan for your employees. The income earned in the retirement account is not taxed until withdrawn.

Simplified Employee Pension Plan (SEP)

A SEP is a written plan that allows you to make contributions toward your own (if you are self-employed) and your eligible employees' retirement account. In a SEP, you make contributions to Individual Retirement Accounts (IRA's) owned by you or your employee.

In order to participate in the SEP, an eligible employee must meet the following requirements:

• Be at least 21 years old
• Have worked for you in at least 3 of the last 5 years
• Has received at least $450 in compensation from you during the year

To start a SEP plan, you must complete a Form 5305-SEP (PDF) by the due date of your tax return. The form becomes the actual pension plan agreement that you give to your employees. Many financial institutions can help you with this paperwork.

SEP Contribution Limits

Your contributions for your employees cannot be more than 15% of the employee's compensation or $30,000, whichever is less. The amount you can contribute to your own plan is based on your net income from self-employment (after deducting your contribution to the employees' accounts). The amount that you can deduct may be less than the maximum contribution. You deduct the contribution you make for your employees on Form 1040, Schedule C (PDF) and the contribution for your own plan on Line 29 of Form 1040 (PDF).

Example:

Your employee, Mary Plant, earned $21,000 for the year. The maximum contribution you can make to her SEP-IRA is $3,150 (15% x $21,000).

SIMPLE Plans

A Savings Incentive Match Plan for Employees (SIMPLE plan) is a written salary reduction arrangement using Simple IRA's. This arrangement is available if you had no more than 100 employees who earned $5,000 or more in the preceding year. Under this plan, an employee elects to have up to $6,000 of his wages paid directly into a Simple IRA. You deposit the employee's contribution into their Simple IRA account each month.

Each year, you either match your employees' contributions (up to 3% of their pay) or contribute 2% of their pay. However, your contribution does not have to be deposited into their Simple IRA until the due date of your tax return.

Employees can participate in the plan if they:

• Were paid at least $5,000 in wages in any two prior years, AND
• Are expected to earn at least $5,000 this year

A self-employed person is also considered an employee. Thus, your contribution to your own plan would be based on your net earnings from self-employment. The SIMPLE plan can be set up as an Individual Retirement Account (IRA) or an individual retirement annuity. Form 5304-SIMPLE (PDF) (employee selects financial institution) or Form 5305-SIMPLE (PDF) (you select the financial institution) make it easier for you to set up the plan and provide the necessary information to your employees. These forms become your written plan, trust document and custodial account document.

Example:

Your employer, John Rose, fills out Form 5305- SIMPLE at State Bank to set up a retirement plan for himself and his two employees. His employees elect to defer 5% of their salary (not to exceed $6,000) to go into the SIMPLE-IRA and John agrees to match the 3%.

John's employee, Hank, makes $2,400 each month. John would have to deposit $120 ($2,400 x 5%) in Hank's IRA account within 30 days following the end of each month. John will deposit his matching funds on or before April 15 of the following year.

Keogh Plan

A Keogh plan, sometimes called a H.R.-10 plan, is primarily funded by the employer. There are two types of Keogh plans - defined benefit and defined contribution. In a defined benefit plan, the retirement income is based upon a contribution formula. In a defined contribution plan, the current contribution is usually based upon an accrual rate, the employee's length of service and the employee's rate of pay. You may need a retirement specialist's help because of the actuarial assumptions and calculations required to determine the contributions.

Employees eligible for the Keogh plan must:

• Be at least 21 years old. AND
• Have worked for you at least one year

A Keogh Plan must:

• Be used by only sole proprietors or partnerships
• Cover all eligible employees
• Be set up by the end of your tax year usually December 31, AND
• Be in writing (Many banks, insurance companies, and mutual funds can provide standard IRS-approved plans)

Keogh Plan Contributions

Your plan must provide that contributions or benefits cannot exceed certain limits. The limits differ depending on whether your plan is a defined contribution plan or a defined benefit plan.

Defined Benefit Plan

Your benefits for your employees under a defined benefit plan cannot be more than the lesser of the following amounts:

• 100% of participant's average compensation for highest 3 consecutive calendar years
• $135,000

Defined Contribution Plan

Your contribution for employees under a defined contribution plan cannot be more than the lesser of the following amounts:

• 25% of the compensation actually paid to the participant
• $30,000

The amount that you can deduct may be less than this. The amount you can contribute to you own plan is based on your net earnings from the business. If you have a net loss in one year, no contributions can be made to your account that year. However, you can still make contributions on behalf of your employees.Deductible contributions can be made up to the due date of your tax return (including extensions).