If you own a small business or are self-employed, you have plenty of retirement planning options. Two of the most popular retirement plans for small businesses (particularly for those who are self-employed or have relatively few employees) are the Simplified Employee Pension (SEP) and the Savings Incentive Match Plan for Employees (SIMPLE). Here’s a side-by-side comparison if you are considering one of these plans:
Set up: A plan administrator (probably you) must fill out a one-page IRS form and give copies to participants. A SEP doesn’t require you to provide the IRS with annual reports.
Eligibility: Contributions must be made for all employees age 21 and over who have worked for your company during three out of the previous five years. (You might have different obligations if your employees work under a union contract.) Employees who meet those criteria but work only part-time, or for just part of the year, must be covered under the plan if they earn a minimum amount ($550 for 2013).
Contributions: The maximum annual contribution you can make on behalf of an employee—and can deduct from the company’s income—is the same as it is for other defined-contribution plans. The limit for 2013 is the lesser of 25% of compensation or $51,000. The maximum amount of compensation that may be taken into account for this purpose is $255,000. These contributions go into a SEP IRA that each participant opens. They are responsible for managing the account and selecting investments, reducing your obligations and risks.
The amount you contribute is discretionary. For instance, you can boost contributions in profitable years or reduce or eliminate them in down years. However, you must contribute the same percentage of compensation to every plan participant.
Vesting: Contributions to a SEP are vested immediately. Even if employees quit right after you make a contribution, they get to keep that money.
Distributions: Distributions must begin by April 1 of the year following the year in which an employee reaches age 70½ (or the year a non-owner employee retires, if that’s later). Withdrawals made prior to age 59½ will normally be subject to a 10% penalty tax as well as regular income tax.
Deadline: a SEP can be set up and funded after the close of the tax year as long as you complete the paperwork by the company’s tax return due date (plus extensions, which could be as late as October 15 of the following year).
Set up: SIMPLEs are generally exempt from most reporting rules. There are actually two varieties: the SIMPLE-IRA and the SIMPLE-401(k). For ease of administration, most small employers favor the SIMPLE-IRA.
Eligibility: A SIMPLE is available only to employers with 100 or fewer employees. Any worker who made at least $5,000 during any two previous years at the company (and who expects to receive at least that amount in the current year) is eligible to participate.
Contributions: For 2013, eligible employees may elect to contribute up to $12,000 to the plan ($14,500 if age 50 or over). As a general rule, the employer must provide matching elective contributions of up to 3% of compensation (but no less than 1% in more than two out of five years) or non-elective contributions of 2% of each eligible employee’s compensation (based on maximum compensation of $255,000 in 2013). Matching contributions are deductible by the employer.
Vesting: Like SEPs, contributions to SIMPLEs are vested immediately.
Distributions: The rules for mandatory distributions from qualified plans after an employee turns age 70½ also apply to SIMPLEs. In addition, withdrawals made prior to age 59½ normally are subject to a tax penalty. But note that the penalty is increased from the usual 10% to 25% for early withdrawals within the first two years of participation. After two years, the normal 10% penalty applies.
Deadline: A SIMPLE must be set up before October 1 of the current tax year.