Small Business Retirement Planning

Understanding SEP IRAs

Retirement plans are a major concern for American workers. As a small business employer, a SEP IRA may be the best vehicle for helping your employees provide for their retirement.

Most U.S. workers are very concerned about planning for their retirement.

But contributing to employees' retirement can be a challenge for small business owners. It's not they don't have the desire to help their workers prepare for their golden years, it's that they lack the capacity.

Retirement benefits are complicated even more by small companies' inability to adequately forecast future earnings. Sure, you can afford to contribute to a retirement plan this year, but what about next year? If you lock yourself into certain retirement plans you won't be able to reduce your financial obligation when your company has a bad year.

SEP (Simplified Employee Pension) IRAs are a win-win retirement option for employees and small business employers. They provide business owners with a high level of flexibility while at the same enabling workers to accumulate significant savings toward their retirements. Managing SEP IRAs is much simpler than other retirement benefit options and startup costs are low. What's not to like?

SEP IRA Overview

With SEP IRAs, a small business employer makes direct contributions to traditional IRAs for all of the company's employees - including the business owner. Startup costs and management requirements for SEPs are low compared to other retirement plans, and you are not required to file any documents with the government. In some scenarios, you may be entitled to a $500 tax credit for each of the first three years of the plan existence as a way to offset startup costs.

The maximum contribution amount for a SEP IRA is 25% of the individual's compensation. Does that sound high? It is. But that's part of the beauty of a SEP IRA. Since you aren't committed to maintain the same level of contributions from year to year, SEPs are ideal retirement plans for companies that experience cyclical or unpredictable revenue streams. The high contribution threshold makes it possible to compensate for low contribution years with higher contributions in subsequent years.

To be eligible to participate in a SEP IRA, individuals must be at least 21 years old and have performed some kind of service for the company during three of the last five years. Even though you aren't required to make any contributions in a given year, if you choose to make a contribution you need to make contributions for everyone who qualifies for the plan. In other words, owners can't contribute to their own SEPs unless they also make contributions for their employees.

Maximum contributions are the lesser of 25% of compensation or $49,000, which shouldn't be a problem unless you employ workers making more than $200k per year. However, you should be aware of the fact that employee salary reduction contributions are not allowed with a SEP IRA - the employer must make the full amount of the contribution on behalf of workers, which is probably why SEPs are most popular with single-person, sole proprietorships.)

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