Important as it is, providing retirement benefits hasn't always been easy for the small employer. Filing required documents with the Internal Revenue Service (IRS) and Department of Labor to establish the plan can be complicated, cumbersome and, as a result, time consuming. Ongoing plan administration and record- keeping can prove overwhelming without a designated benefits or accounting department. And getting someone else to handle these functions for you can be expensive.
Add to that fiduciary responsibilities, intricate vesting schedules and often stringent contribution requirements, and it becomes clear why qualified retirement plans have historically been a big headache for the small business owner.It's with these small companies in mind that Congress created the Simplified Employee Pension (SEP) plan in 1978.
As its name suggests, the hallmark of SEP is simplicity. And as an increasing number of smaller employers and self-employed individuals can attest, it is an easy and inexpensive solution to their retirement plan needs.
Easy to establish and maintain
An SEP is, quite simply, an Individual Retirement Account (IRA) you establish for yourself and, if applicable, each of your eligible employees. Each employee maintains his or her own "SEP-IRA" account so there is no filing with the IRS or Department of Labor. All individual participants assume fiduciary responsibilities for their own account. Bottom line: There is only minimal paperwork and bookkeeping to establish and maintain an SEP, and costs for consultants, lawyers, accountants and actuaries are sharply reduced - and may even be eliminated.
With SEP, the employer can make tax-deductible contributions of up to 15 percent of compensation or $30,000, whichever is less, for himself and each eligible employee. Because these contributions are considered "discretionary," employers can choose to change the level of contributions from year to year or even skip making contributions altogether.
There are two general rules when it comes to employer discretionary contributions, however. You must contribute the same percentage of compensation to each eligible employee's SEP-IRA as you do to your own account; and You must make a contribution on behalf of all eligible employees. Employers can choose to establish certain eligibility requirements, but, in general, employees who are at least 21 years old and have worked for the company three of the past five years must be covered.
Like an IRA
The SEP helps the small business owner and professional plan for tomorrow's retirement needs while enjoying valuable tax deductions today. Another important benefit for small businesses with employees is goodwill - employees like SEP. From the employees' perspective, the SEP-IRA account acts very much like a normal Individual Retirement Account. In fact, employees may make their own yearly Individual Retirement Account contributions directly into the SEP-IRA. All money contributed to the account - employer and employee - grows without being taxed for as long as it remains in the plan and is always fully vested.
Money comes out of the SEP plan like an IRA too - at age 591/2, you and your employees may begin making penalty-free withdrawals. And you can, if you want, wait until age 701/2 to start taking minimum distributions from the plan.
One of the primary advantages of SEPs over IRAs is that more money can be contributed each year since the IRA has a yearly contribution limit of $2,000 per person (plus $250 for non-working spouse) vs. 15 percent of compensation and up to $30,000 for SEPs. Also, unlike IRAs, all SEP contributions remained full tax-deductible after the Tax Reform Act of 1986 (TRA '86).
Investment flexibility is key
Any investment allowed in an Individual Retirement Account is suitable for a SEP, including bonds, stocks, mutual funds, unit trusts, etc.
Who can establish SEP?
The SEP could prove beneficial whether you're a small- to medium-sized company, corporation or Subchapter S corporation, partnership, sole proprietor, professional association or individual with outside income such as consulting or director's fees. The SEP-IRA can be used as a first retirement plan, because it is so easy and inexpensive to establish and maintain, or as a second plan to allow for additional contributions at the employer's discretion. Because of its simplicity and flexibility, it's especially well-suited for new businesses or companies with a volatile profit history.
A salary reduction option
Certain smaller employers - those with 25 or fewer eligible employees - can also choose to take advantage of a salary reduction option for SEPs, introduced by the Tax Reform Act. It's called "CODA SEP" (Cash or Deferred Arrangement SEP), and it's an ideal way for small businesses to shift part of the rising cost of retirement benefits to employees, while helping them meet their retirement saving needs.
Like a 401 plan, CODA SEP lets employees make their own, pre-tax contributions to the plan through automatic payroll deductions. Contributions can be up to the lesser of 15 percent of salary or
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$8,475 (for 1991, as indexed for inflation), and are free of federal and, in many cases, state and local income taxes. They also grow tax deferred. One difference from the 401 plan is that no employer "matching" contributions are allowed.
Two guidelines must be met by eligible small businesses to establish CODA SEP: at least 50 percent of eligible employees must participate in the plan; and an "anti-discrimination" test must be satisfied, assuring that the amount contributed by each employee at the high end of the pay scale as a percentage of their pay can be no more than 125 percent of the average contribution of all employees.
If you're looking to spend more time running your business than administering your retirement plan, the SEP is worth considering as a simple, low-cost alternative to a profit-sharing or "Keogh" plan.
To find out more about the Simplified Employee Pension plan, contact your investment adviser.
Kim D. Isaacson is vice president-investment with the Salt Lake City brokerage office of Paine Webber.