Simple and SEP: Benefits without Hassles

03/07/07

Does the ongoing expense or administrative burden of setting up a 401(k) scare you off?

You have a couple of options that provide many of the same benefits as does a 401(k)—a boost in loyalty and retention, the ability to recruit higher caliber candidates, and tax deductions among them but without the paperwork or expense.

SIMPLE
One such plan is the Savings Incentive Match Plans for Employees of Small Employers (simple for short). It comes in two flavors—the SIMPLE-IRA and the simple-401(k). Most people opt for the IRA version, so that’s what is discussed here. Here’s a summary of features.

Eligible Employers: Employers must have one hundred or fewer employees who made $5,000 or more in income the preceding year. In general, employers can’t offer any other plan. The plan must be made available to all eligible employees, although you can exclude unionized employees who have a different plan.

Eligible Employees: Employees must have made at least $5,000 in the preceding two years, with the reasonable expectation of making $5,000 in the current year. Employers can set less stringent requirements for instance, opening up the plan to those who’ve made $2,500 in just the last year but they can’t make the eligibility requirements more stringent.

Contributions: Employees can have up to $6,000 per year withheld from their paychecks. The money goes into an IRA account that can be designated by the employer, or one of the employee’s choosing.

Employer contributions are mandatory, but you have two options:

Match employee contributions up to 3 percent of compensation. (This figure is somewhat flexible. In lean years you can reduce it to as low as 1 percent but only for two years out of any five-year period.)

Contribute a flat 2 percent of an employee’s salary.

Vesting: All contributions vest 100 percent immediately.

Notification: You must notify eligible employees of their options, give them at least sixty days to opt in, and provide a plan summary, among other things.

There are major benefits with SIMPLES:

1. There’s almost no paperwork. Even the IRS form you use (5304 or 5305) is meant to be filled out and filed—not sent to the IRS. And most employers engage a mutual fund company to handle investments. It will take care of the paperwork.

2. No testing. Highly Compensated Employees? Top Heavy? No problem. With simple plans, there’s no testing for discrimination in favor of owners or other high income employees.

SEP-IRAs
Also popular are Simplified Employee Pension, or SEPs. These plans, too, are IRAs dressed up in different clothing but nicer, richer clothing, thanks to generous contribution rates.

SEPs, like simples, offer greatly reduced paperwork and ad-ministrative expense. The SEP form, 5305-SEP, is itself a model plan that provides the paperwork you need.

SEPs vs. SIMPLEs
SEPs have three features that separate them from simples. First, all contributions are made by the employer. There is no salary reduction program for employees.

Second, the employer can contribute up to 15 percent of an employee’s salary or $30,000, whichever is less. That means a highly compensated employee can rack up a hefty balance within a short period.

Third, you decide the percentage contribution you’ll make each year. It can even be zero.

The downside (perhaps): You have to give every eligible employee the same percentage contribution. Thus, the lazy marketing assistant gets the same 15 percent of salary that the hardworking CIO receives. This could be a problem if you’d rather not reward a mediocre employee with a large pension contribution.

Get More Information
The regulations governing simples and SEPs throw a few curve balls at you. For instance, with SIMPLEs you don’t withhold federal tax from employee contributions, but you do withhold FICA. Easy-to-read IRS and PWBA documents clarify most issues.