How to choose the Best retirement plans for small business owners

V. Kumar By V. Kumar, 24th Apr 2011 | Follow this author | RSS Feed | Short URL http://nut.bz/q0_-s3kt/
Posted in Wikinut>Money>Pensions

Small business owners need to provide retirement benefit for their employees as well as take care of their own retirement planning. There are many plans that take care of their requirements, and also provide similar tax benefits as are available to employees of large corporations.

Retirement Plan options for small business owners

The main retirement plans for the small business owners are the SEP plan, the SAR-SEP plan, the SIMPLE plan and the H.R. 10 or KEOGH plan. Each of them comes with more than one options. Each of these plans offer the small business owners and their employees a tax-favored way to save for retirement. The contributions made to the plan by them are tax deductible. The trustee's fees can also be deducted if contributions do not cover them. Earnings on the contributions are generally tax deferred, i.e.. not taxed until you receive distributions from the plan.

1. SEP PLAN (Simplified Employee Pension Plan)

A Simplified Employee Pension (SEP) Plan is an individual retirement account for a small business owners that can also be used for its employees, if their number is less than 25. All contributions are tax deductible as a business expense and can be integrated with Social Security contributions, and there is no minimum contribution requirement. The maximum contribution under this plan for 2008 is $46,000 or 25% of participant's net compensation, whichever is less, in case of employees. In case of the business owner, it is 20% of earnings.

The SEP plan can be managed as a 'profit sharing plan' where contribution is linked with the annual profits, or it can be 'mandatory annual contribution' in which each year the same contribution will have to be made irrespective of the profit in that year, and the same will have to be extended to all employees who have been employed for at least three years and received at least $ 500 in 2008. Another option in this plan is to have 'Individual Retirement Account' for each beneficiary, or to have 'individual Retirement Annuity' (SEP-IRA).

A SEP plan as per the model prescribed by IRS can be easily set up by executing a formal agreement in Form 5305-SEP, in which case no further prior approval of IRS, nor any determination letter is required. Part of the costs of setting up the SEP plan can also be claimed as tax credit, as per the details prescribed by IRS in Publication 560. SEP-IRA cannot be designated as Roth IRAs nor do they affect the limits of contribution by the individual in Roth IRA.

2. SARSEP (Salary Reduction Simplified Employee Pension)

A Salary Reduction Simplified Employee Pension (SARSEP) plan is a SEP plan wherein contributions are made by way of a salary reduction arrangement. Employees can choose to have the contributions paid directly to their SEP-IRAs. Such contribution is called an "elective deferral" because employees choose not to receive it, and the tax on it is thereby deferred until it is distributed to them. SARSEP can not be set up after 1996, though participants (including employees hired after 1996) in a SARSEP set up before 1997 can continue to be covered by it.

SARSEP needs several requirements to be met, like 25 or fewer employees during the preceding year, and at least 50% of eligible employees choosing to make elective deferrals. The elective deferrals of the highly compensated employees must meet the SARSEP ADP test, a test designed to ensure fair play by the employer.

In a SARSEP plan, the participants have the option of not treating their elective deferral as compensation. The IRS prescribed limit on maximum deferral for 2008 is $ 15,500 or 25% of compensation. Those over 50 years can make additional 'catch up' contribution of up to $ 5000.

3. 'SIMPLE' PLAN (Savings Incentive Match Plan)

The 'Savings Incentive Match Plan' or 'SIMPLE' plan is a retirement plan that can be used by small business owners for themselves and their employees, provided the number of employees is less than 100 and they have received at least $ 5000 in compensation during the preceding two years. These programs are attractive because they don't incur many of the administrative fees and paperwork of plans such as the 401(k). In this plan, the contributions are made in two forms, the Elective Salary Reduction Contribution, and the Matching or Fixed Non-Elective Contribution. The contributions are tax deductible and free from tax up to $ 10,500 for salary reduction contribution, and up to 3% of compensation in case of matching, and 2% of compensation in case of fixed non-elective contribution.

3. KEOGH Plan or H.R. 10 Plans

H.R. 10 Plans or Keoghs plans are also known as 'Qualified plans' when used for employees. These are tax-deferred retirement plans which can be a useful option for small businesses. In a Keogh Plan, employees working over 1,000 hours or more in a year or employees working for over three years must be covered. The employer can only take up to 25% of his or her income or $40,000.

These are of two types. Defined contribution Keogh plans and Defined benefit Keogh plans.

A) Defined Contribution Keogh Plans

Defined Contribution Keogh Plans can be further separated into profit sharing and money purchase plans. In both of them, maximum contributions are limited to a maximum of 100% of the participant's income, or $45,000, while the maximum tax-deductible amount is limited to 25% of the participant's income. Contributions and earnings can grow tax-deferred until withdrawal. There are two options for distribution. A single lump sum payout or monthly payouts. For lump sum distributions, 20% of the amount is reported each year for five years. Monthly distributions are taxed as ordinary income for each year received.

Money Purchase Plan - In this plan, the employer has to contribute the same percentage every year, regardless of the company's profits.

Profit Sharing Plan - Theses plans allow for changing contributions each year, determined by a formula to allocate the overall contribution and distribution of accumulated funds after the retirement age.

B) Defined Benefit KEOGH Plans
Defined Benefit Keogh plans assure a certain benefit after a particular time, and the contribution to them will need to be calculated by an 'actuary'. To that extent they are complex to operate. The maximum contribution allowable is the amount required to provide an annual benefit of (lesser of) $ 180,000 or maximum compensation of the beneficiary in her highest three consecutive calendar years.

In addition to these specific plans, small businesses can also opt for traditional IRA account or 401 (k) account.

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Comments

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28th Sep 2012 (#)

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