SEP
A Simplified Employee Pension Plan is an individual retirement account for a self-employed person or a small company with less than 25 employees. This plan allows employers to contribute on behalf of eligible employees. All contributions are tax-deductible as a business expense and can be integrated with Social Security contributions, and there is no minimum contribution requirement.
- Contributions: All contributions must be money (cash or check), not stocks or bonds. Contributions are tax-deductible, and the employer can contribute up to 25% of an employee’s compensation, not to exceed $40,000 (indexed annually for inflation).
Only the employee’s first $200,000 is subject to the employer’s contribution which must be the lesser of 25% or $40,000. Employers are not required to make annual contributions; however, if they are made, all eligible employees must receive those contributions. Possible investments include stocks, mutual funds, and bonds. Earnings on contributions are taxed until withdrawal.
- Eligibility: Employees must be at least 21 years old, have earned at least $450 in wages, and might be required to work for a minimum of three years to be eligible to participate in this plan. Participants are automatically vested in this plan, regardless of when they leave the company.
- Withdrawals: Participants can withdraw the money at age 59 1/2, prior to that there is a 10% penalty or exercise tax. Withdrawals are then calculated as annuities, which cannot be changed until the participant reaches age 59 1/2 or after five years.
- Distributions: Distributions are taxable in the year they are received.
SIMPLE
The Savings Incentive Match Plan for Employees is a retirement plan sponsored by employers. These programs are attractive for employers because they don’t incur many of the administrative fees and paperwork of plans such as the 401(k). Employers also benefit from the tax-deductible contributions to the plan. Employees may elect to have salary deferrals to contribute to the plan.
- Contributions: The employer has the option of matching the employee’s deferrals up to 3% of the annual salary or making non-elective contributions of 2% or less to all eligible employees. In both cases, the employer’s contributions cannot exceed $8,000 a year.
- Eligibility: Employees who have received at least $5,000 in compensation during the past two years are eligible for this plan. Exceptions include nonresident aliens that did not receive income from U.S. sources and employees acquired through an acquisition. Employees cannot establish any other qualified retirement plans.
- Participation: An employee can elect to participate in a plan or make changes to contribution amounts within the first 60 days of any year. The employer is required to contribute within 30 days after the end of the month to which the contributions relate. Participants can choose to terminate their participation at any time.
- Withdrawals: Participants can make withdrawals without penalties after the age of 59 1/2. Before that, there is a 25% penalty tax and ordinary income taxes on money withdrawn in the first two years, or 10% after that.
Taxes
As an employer, contributions to employees’ SIMPLE accounts are tax-deductible, which makes these plans very attractive.
For participants, their contributions are tax-deductible, and the earnings can grow tax-deferred until withdrawal. A SIMPLE account can be rolled over into a traditional IRA tax-free after the first two years. If it has been two years since the employee left the company, the SIMPLE account is treated as a traditional IRA.
Matching contributions by an employer and non-elective contributions are not subject to employment taxes such as FICA and Medicare. However, if the participant is self-employed, these contributions are subject to self-employment taxes.
