I ve found that clients in a position to start one of these plans usually ask five questions initially. What kind of plan am I eligible to establish?

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1 Lately, I find that more people who have had successful corporate careers are choosing to become self-employed consultants or starting a small business with several employees. If you are one of those people, these next few slides have information just for you about plans designed to encourage smaller-business owners and self-employed individuals to provide retirement planning benefits to themselves and their employees. These plans provide less cumbersome ways for you to provide the same retirement benefits as a larger company. Just as importantly, they give you the potential to increase your retirement savings well beyond what you can contribute to an IRA. I ll explain two small-business retirement plans that use IRAs as the funding vehicle but have different rules. They are the simplified employee pension (SEP) plan and the Savings Incentive Match Plan for Employees (SIMPLE). We ll also look at why 401(k) plans are being adapted for individual use.

2 I ve found that clients in a position to start one of these plans usually ask five questions initially. What kind of plan am I eligible to establish? Who funds the plan? The business or the employees (i.e., plan participants)? What are the tax benefits of the various plans? What is the maximum amount I could contribute? How much administration is required? The table here gives you a high-level view of how three types of widely used plans compare on the first three points: eligibility, funding and tax benefits. As you can see, eligibility is defined quite differently for the SIMPLE IRA as compared to the other two. The SEP IRA is funded solely by the employer; the SIMPLE IRA, by the employer and employee; and the Individual 401(k) by the business owner as both employer and employee. While all the plans provide tax-deferred growth, they differ with regard to other types of tax benefits for the business and employees. As for administrative responsibilities, the SEP and SIMPLE require no tax filings with the IRS, just certain notifications to employees. The Individual 401(k) may require an annual filing with the IRS. Now, let s delve into each of the plan types shown here, including the answers to the fourth question, about contribution rules.

3 SEP IRA is the acronym for Simplified Employee Pension Individual Retirement Account. Basically, SEPs are IRAs established and maintained by employees but to which an employer contributes. Many features associated with a qualified plan, such as eligibility requirements and contribution limits, are applicable in the case of a SEP, but with some major differences. A SEP can be established by any business without a retirement plan. Once the plan is established, which is usually a relatively easy process, each eligible employee must open his or her own SEP IRA account. Here you see the participation requirements from the IRS model plan document. Customizing a plan with different eligibility is possible but may be costly. SEP IRAs offer business owners maximum flexibility for contributions providing the ability to scale contributions based on employee wages and to change contributions depending on business conditions.

4 What rules apply to the contributions? Contributions are made by the employer but are not required every year. As an employer, when you do choose to make contributions, the percentage you contribute can vary from previous years, but the percentage of compensation contributed for each eligible employee in any given year must be the same. In 2013, for each employee, employers can contribute up to 25% of the first $255,000 of annual compensation up to a statutory limit of $51,000. If you are self-employed, compensation means earned income. For example, assume a sole-proprietor consultant with $255,000 of earned income in 2013 wants to max out his contribution at $51,000. The first $255,000 of earned income would be eligible. That, multiplied by a contribution percentage of 20%, would equal the goal. ($255,000 x 0.2= $51,000) If the sole proprietor has an eligible employee on staff, he would have to contribute 20% of the staffer s compensation (up to $255,000) to the staffer s SEP IRA account. Contributions are tax deductible for you as the employer and, from an employee s standpoint, are nontaxable. Like any IRA, the contributions can grow tax deferred until withdrawn, withdrawals after age 59½ will be taxable income, and premature withdrawals may be subject to a 10% tax penalty. SEP IRAs are an attractive option for employers that wish to establish and fund a retirement plan for their employees that requires minimal work to maintain.

5 One key advantage of the SEP is that employees choose their own investment vehicles, so you are relieved of investment fiduciary responsibility. On the other hand, employees are 100% vested at all times. Unlike a 401(k), there cannot be a vesting schedule that stipulates how long an employee must wait before he or she owns 100% of the employer contributions; employees may withdraw funds or roll them over at their discretion at any time. Another feature of a SEP is that the participants can roll over distributions from other qualified plans such as a former employer s 401(k) plan into the SEP IRA. SEPs are not completely free of administrative requirements. As I just mentioned, eligibility requirements must be established. Also, you must test annually to identify whether contributions are top-heavy, meaning that they discriminate in favor of highly compensated employees. That said, I should mention that they can also be intentionally designed to be top-heavy, in which case a minimum 3% contribution is required in any year that contributions are made. Other drawbacks of SEPs are that, like IRAs and unlike 401(k)s, you cannot borrow SEP assets as a participant loan, and they are not necessarily protected from creditor claims under ERISA or federal law.

6 Another way to use IRAs as part of a small-company retirement plan is a SIMPLE IRA. SIMPLE IRAs can be established by employers that have 100 or fewer eligible employees, and have no other employer-sponsored plan. An eligible employee is defined as one who earned at least $5,000 from the employer in any two prior years and is expected to do so in the coming year. Here s how SIMPLE IRAs function. You must announce a 60-day enrollment period. During that period, an eligible employee can elect to have salary diverted, pre-tax, to his or her SIMPLE IRA similar to how 401(k) participants choose to have a portion of their salary contributed to a personal 401(k) account. Employee pre-tax contributions can be up to the lesser of compensation or $12,000, plus an additional $2,500 in catch up contributions for workers age 50 and older for You, as the employer, contribute in one of two ways. Either you make a matching contribution of up to 3% of employee compensation for each participating employee, or you make a non-elective contribution for all eligible employees, whether or not they actively participate in the plan. This non-elective contribution must be equal to 2% of each eligible employee s annual compensation. Contributions are not subject to income tax for the employee (though they are subject to FICA) and are a deductible business expense for the employer.

7 So, you can deduct the contribution to your own SIMPLE IRA from your company profits but needn t include the contribution in your personal taxable income. As with SEP IRAs, employees own their accounts and their full value at all times and make all investment decisions. Likewise, the distribution, rollover and transfer rules are generally the same as with a Traditional IRA. One notable exception for SIMPLE IRAs is that a distribution from another type of qualified plan cannot be rolled over to a SIMPLE IRA. As an employer, a SIMPLE IRA can give you one key advantage over other alternatives such as a 401(k) plan. The way a SIMPLE IRA is structured with mandatory employer contributions automatically addresses certain potential problems, such as creating a topheavy plan in which the contributions favor highly compensated employees. Because of this, SIMPLE IRAs eliminate top-heavy rules and nondiscrimination testing. That, plus the fact that employers needn t choose investment options, makes the SIMPLE relatively easy to administer. SIMPLE IRAs may be more attractive if you have less than 100 employees, want employees to be able to contribute to their own accounts or want to limit employer contributions to the plan. On the other hand, the relatively low contributions limits may severely inhibit your own ability to save for retirement.

8 An Individual 401(k) plan covers a sole proprietor, a one-person corporation or a small partnership that has no non-owner employees other than a spouse that is employed by the business. The retirement savings benefits can be significant. Not only can you make a salary-deferral contribution as a plan participant, but as the owner of the business, you can also distribute company profits to yourself via a tax-advantaged profit-sharing contribution. Here you see the maximum deferral and catch-up salary deferrals for On top of these, you can make a profit-sharing contribution, provided the total contributions do not exceed 25% of your first $255,000 of compensation, or $52,000 ($57,500 with catch-up contributions for ages 50 or older).* Both the salary-deferral and profit-sharing contribution will enjoy tax-deferred growth until withdrawn. Withdrawals will generally be fully taxable and, if made early, subject to a 10% withdrawal penalty tax *Note: Pre-tax and Roth options are available.

9 Here you can see two examples of SEP IRA and Individual 401(k) contributions. In the first, the person s eligible compensation is $100,000, far below the $260,000 maximum for 2014, and he is age 50, making him eligible for a catch-up contribution in the Individual 401(k). In this instance, the Individual 401(k) may be a better choice if maximizing retirement savings is the primary goal. The Individual 401(k) allows him to defer $22,500 more than the SEP-IRA in this hypothetical case. Now look at the second example. The subject is younger age 35 and has compensation of at least $260,000, the maximum includable compensation for He can make the permissible maximum contribution of $52,000 with the SEP-IRA or the employer contribution to the Individual 401(k); no salary-deferral election is needed to max out his contribution. Since the SEP-IRA is easier to set up and administer than the Individual 401(k) and he s still too young to take advantage of catch-up salary deferrals, the SEP-IRA might better suit his needs. Of course, these are only hypothetical examples and shouldn t be taken as hard-and-fast recommendations. Every case is different. I would be happy to help you analyze your business and income circumstances and discuss your savings goals, in order to help you select an appropriate option.

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