The decision to implement a retirement plan is one of the smartest choices that a business can make. It can give you and your employees the opportunity to save for your future while enjoying substantial tax savings today. The benefit to a business owner is twofold. First, as a business owner, a company-sponsored retirement plan can help you attract and retain your most valuable business assets – quality employees. Secondly, as a participant, a retirement plan will allow you to save for your own retirement.
Simplified Employee Pension
A Simplified Employee Pension Plan, or SEP, may be an ideal choice for self-employed individuals or small businesses because it is very easy to administer. A SEP can provide many of the benefits of a standard retirement plan, and is easy to establish and maintain. A SEP can also give you more limited responsibility as an employer. Each of your employees is responsible for his or her own SEP-IRA account. This means less administrative hassle for you, and also there is a comparatively small amount of government reporting. The typical candidates for establishing SEP accounts are sole proprietors, consultants, and small businesses — especially those with high turnover rates or younger employees.
How a SEP works
How much may be contributed to a SEP?
Annual contributions an employer makes to an employee’s SEP-IRA cannot exceed the lesser of:
- 25% of compensation, or
- $44,000 for 2006 ($45,000 for 2007 and subject to annual cost-of-living adjustments for later years).
The limits in the preceding sentence apply in the aggregate to contributions an employer makes for its employees to all defined contribution plans, which includes SEPs. Only up to $220,000 in 2006 ($225,000 in 2007 and subject to annual cost-of-living adjustments for later years) of an employee’s compensation may be considered. Contributions must be made in cash. Property cannot be contributed.
All employees who meet the following criteria must be included in the plan:
- Age 21 or higher
- Employed by you for any amount of time during three of the last five years, and
- Received at least $450 ($500 for 2007) of compensation from you in the current year
*for more info, please consult the IRS website
Profit Sharing & Money Purchase
Qualified Retirement Plans like Profit Sharing and Money Purchase Plans are types of retirement plans that are funded by the employer. They allow employers to contribute to an employee’s account, while offering them business tax deductions and tax-deferred savings.
How the Profit Sharing Plan works
Profit Sharing Plans are designed for companies with fluctuating or uncertain profits. These plans can be established by sole proprietors, partnerships, or corporations. Companies can make a discretionary contribution of up to 15% of an eligible employee’s total compensation. In a Profit Sharing Plan, the employer has the flexibility to determine the contribution amount each year. Contributions do not have to be dependent on profits. Contributions by the employer are tax deductible as a business expense and are not treated as taxable income to the employee.
How the Money Purchase Plan works
In Money Purchase Plans, the employer’s contribution is mandatory. The contributions are usually based on each employee’s compensation. The employer sets specific eligibility and vesting requirements, and contributions can be as high as 25% of total compensation or $30,000 whichever is lower. Money Purchase Plans are less flexible than Profit Sharing Plans because contributions must be made even if the company has no profits.
Profit Sharing & Money Purchase Combination
Many companies choose to implement both of these types of plans in conjunction with one another. This allows for a greater total contribution percentage. By combining these two types of plans, an employer can effectively contribute 25%, up to $30,000. A typical example of how this works is an employer making a 10% mandatory Money Purchase contribution, and a discretionary 15% contribution into the Profit Sharing Plan. This type of approach offers some flexibility while maximizing the potential contribution percentage.
SIMPLE IRA Plan
The Savings Incentive Match Plan for Employees-IRA replaced the SARSEP-IRA for plans established after January 1, 1997. A SIMPLE-IRA is specifically designed for companies with less than 100 employees. Companies with more than 100 employees cannot use the SIMPLE Plan. Additionally, companies cannot maintain or contribute into any other type of retirement plan. In a SIMPLE Plan, contributions are made by both employer and employee. Contributions are made on a pre-tax basis, thus giving added tax benefits to the plan’s participants.
How a SIMPLE Plan works
What type of contributions may be made to a SIMPLE IRA plan?
Each eligible employee may make a salary reduction contribution and you must make either a matching contribution or a nonelective contribution. No other contributions may be made under a SIMPLE IRA plan.
How much may an employee defer under a SIMPLE IRA plan?
An employee may defer up to $10,000 for 2006 ($10,500 for 2007 and subject to cost-of-living adjustments for later years). Employees age 50 or over can make a catch-up contribution of up to $2,500 for 2006 ($2,500 for 2007; subject to cost-of-living adjustments for later years). The salary reduction contributions under a SIMPLE IRA plan are “elective deferrals” that count toward the overall annual limit on elective deferrals an employee may make to this and other plans permitting elective deferrals.
How much must be contributed for employees participating in a SIMPLE IRA plan?
In addition to the employees’ salary reduction contributions, the employer is generally required to match each employee’s salary reduction contribution on a dollar-for-dollar basis up to 3% of the employee’s compensation. Instead of the matching contribution, the employer may choose to make nonelective contributions of 2% of the employee’s compensation (compensation used for this contribution is limited to $220,000 in 2006, $225,000 in 2007 and is subject to cost-of-living adjustments for later years). If the employer chooses to make nonelective contributions, it must make them for all eligible employees whether or not they make salary reduction contributions. However, the employer may choose to give the nonelective contributions only to eligible employees who make $5,000 or more in the year, if the document so provides.
*for up to date & more info please consult the IRS website
The 401(k) Plan is probably the most widely-used company retirement plan. The term 401(k) refers to the section of the Internal Revenue Code which permits employees to defer part of their income into a company-sponsored retirement plan. A 401(k) Plan is a great way to attract and retain employees. 401(k) Plans allow for contributions by both the employee and employer. A profit-sharing contribution can also be made by the employer. This type of contribution is at the discretion of the company. A matching contribution may also be made by the employer on behalf of the employees. This type of contribution is mandatory if that option is selected as a plan feature.
How a 401(k) Plan works
The flexibility of a 401(k) Plan allows companies to select plan features to achieve specific goals for your company and your employees. A plan must set specific eligibility requirements and vesting schedules. A 401(k) Plan may require that employees be age 21 and/or completed at least one year of employment with the company in order to participate. If the plan calls for immediate vesting, two years of employment may be required prior to becoming eligible.
Vesting is another term for ownership of the account balance and is determined mainly by the source of the funds. Contributions that employees make are always 100% vested, meaning that they always own all of the money that they contribute into the plan. Contributions that employer’s make may follow a schedule in which the vesting percentage increases with each year of employment. The maximum number of years before an employee is fully vested is seven. This is at the employer’s discretion and can be less than seven years.
There is a maximum limit on the total yearly employee pre-tax salary deferral. The limit, known as the “402(g) limit”, is $15,500 for the year 2007 . For future years, the limit will be indexed for inflation, increasing in increments of $500. Employees who are 50 years old or over at any time during the year are now allowed additional pre-tax “catch up” contributions of up to $5,000 for 2006 and 2007. The limit for future “catch up” contributions will also be adjusted for inflation in increments of $500. In eligible plans, employees can elect to have their contribution allocated as either a pre-tax contribution or as an after tax Roth 401(k) contribution, or a combination of the two. The total of all 401(k) contributions must not exceed the maximum contribution amount. Employee contributions and company matching contributions cannot be more than 25% of an employee’s total compensation. Employers can alter their matching contributions from year to year.