If you have a small business with no employees but yourself and are considering starting a retirement plan, you might want to look at a SEP IRA or a SIMPLE IRA. While there are other retirement plan options, there are a number of characteristics of SEP and SIMPLE IRAs that make them ideal for a one-employee business.
1. They are low cost retirement plan options they are easy to set up.
2. Their ongoing administrative and management costs are low.
3. Contributions to these plans vest immediately.
4. They can be used by most forms of business, including sole proprietorships, partnerships, corporations, and S corporations.
Whether you choose a SEP IRA or a SIMPLE IRA for your small business will depend on your retirement plan priorities. The principal differences between SEP and SIMPLE IRAs to consider when making your decision include the following.
1. Funding responsibility. A SEP IRA is funded entirely by the employer, while a SIMPLE IRA is funded by both employees and employers.
2. Plan contribution limits. Employer contributions to a SEP IRA are allowed up to 25% of compensation (20% of net adjusted earnings for sole proprietors) with a maximum contribution of $49,000 for 2011. In a SIMPLE IRA plan, employees can contribute up to 100% of compensation. The maximum contribution is $11,500 for 2011 (or $14,000 for employees age 50 or older). In addition, employer contribution matches can be as much as $11,500.
3. Mandatory employer contributions. There are no mandatory contributions to a SEP IRA, allowing the employer (you) to adjust contributions as necessary depending on the business’s cash flow and cash requirements. On the other hand, the employer must match employee contributions up to 3% of compensation for eligible employees in a SIMPLE IRA.
4. Tax deductibility of contributions. Employer contributions to a SEP IRA and SIMPLE IRA matching contributions are deductible to the business. Employee contributions to a SIMPLE IRA reduce gross income for tax purposes (although not for payroll taxes).
Whether you choose a SEP IRA or SIMPLE IRA for your business may depend on your retirement plan priorities. For many business owners, the priority is to maximize contributions. In that case the better choice will depend on income. For example, if you have an S corporation and your compensation from the business is $52,273, your business can contribute up to $13,068 into your SEP IRA for you. If you have a SIMPLE IRA, you can contribute as much as $11,500 into your IRA yourself and your business can match up to the first 3% of your compensation or $1,568, bringing the total contribution to your SIMPLE IRA for the year to $13,068. As this indicates, $52,273 is the breakeven compensation level at which, based only on this factor, it wouldn’t matter whether your business chose a SEP IRA or SIMPLE IRA. However, if your compensation is lower than this, the SIMPLE IRA would allow you to make larger contributions to your account, and if it is higher, the SEP IRA has the contribution edge.
There is one other wrinkle to this calculation. If you are 50 or older, you can make a catch-up contribution of up to $2,500 to your SIMPLE IRA. Therefore, for those who qualify for this additional contribution, the breakeven compensation rate for the example above is $63,635.
Rande Spiegelman, CPA, CFP, www.schwab.com , Small Business Retirement Plans
www.usaa.com , SEP vs. SIMPLE IRAs, USAA
Brian Huber, www.ehow.com , How to Do Payroll Deductions with SIMPLE IRA/eHow.com
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