SEP IRA or individual 401k plan... What is the right choice for your company? This article will hopefully answer questions you may have in regards to deciding on what you will want for your company. Both retirement vehicles are beneficial to small companies and allow for the participants to prepare for a better retirement. But what are the differences?
The Simplified Employer Pension Plan typically is for self employed business owners that want to put tax deferred savings aside for retirement. The plan allows for the individuals of the company to contribute up to 25% of their wages or 20% of their net earnings into their retirement savings plan. The total dollar amount per year as of 2010 is $49,000.00. Other benefits of choosing a SEP IRA is: • The paperwork is easy to set up and has low administrative responsibilities • You are investing into a tax deferred vehicle that will allow you to defer your taxes until retirement. • Discretionary contributions (contributions can vary year to year or can be stopped all together based on profitability of the company)
While Simplified Employer Pension Plan's tend to be easy to design and manage, there are additional items to understand. Below are some issues that you will want to take into consideration: • A SEP IRA is funded 100% by the employer, employees do not contribute. • Annually the employer would make a contribution to their own SEP IRA account and to each eligible employee's SEP IRA account. • The percentage contributed into each SEP IRA account is the same percentage for the employer and each eligible employee. • Part time and seasonal employees must be included in the SEP IRA. ( if they have earned $450 or more in the current year, are 21 or older and have worked 3 out of the last 5 years, then, they must be included in the benefits of the SEP IRA)
The Individual 401k or Defined Contribution plan is used by businesses small and large. The 401k plan allows for tax deferred contribution up to $16,500 or $22,000 if you are over the age of 50 ( catch up provision allows for an additional $5500 per year for those over the age of 50) per year and has a profit sharing component that allows for the same benefit as the SEP IRA, whereas, in addition to the $16,500, a participant can also invest up to the 25% of wages or 20% of net earnings into their retirement savings plan. The total tax deferred contributions per year are $49,000.00 ($54,500.00 if over the age of 50 due to a catch-up provision), but with a 401k plan, a plan sponsor or benefit administrator can also design the plan to allow for an additional Defined benefit for its participants. ( I am not going to talk about Defined Benefits in this article, but, I will be writing an article on that in the near future.)
Some of the issues that you will want to consider before setting up a 401k plan are: • Individual 401k plans have greater administrative responsibilities than a SEP IRA • Individual 401k plans have higher fees. • Participants are responsible for their own contributions. • The Sponsor or Administrator may or may not provide matching contributions. • The Plan Sponsor or Administrator becomes a fiduciary and holds a higher degree of risk • The Plan must file a form 5500 annually and may have annual plan audits • The plan has to consider certain tests (Actual Deferred Percentage, Actual Contribution Percentage) to demonstrate non discrimination issues.
The issues mentioned above are issues that typically are handled or assisted with by the Plan Provider, the Investment Advisor and/or the Third Party Administrator. These entities are the support system for all 401k plans.
One other benefit I would like to mention in regards to a 401k plan that is not provided to a SEP IRA is the option of borrowing against your 401k retirement plan. By using your balance as collateral, you as a participant can loan yourself money. IRS rules do not permit a loan in a SEP IRA, but an Individual 401k loan of up to half of the plan's value or up to a $50,000 maximum is allowed.
Lastly, it is important to note that you can convert your SEP IRA to an Individual 401k at anytime. Converting from a SEP IRA to an Individual 401k and transferring retirement assets to the 401k can be accomplished by completing some minor administrative paper work.
Disclosures
* This article is for informational purposes only and does not constitute, and should not be construed as, professional, legal or tax advice. To determine your individual tax situation and specific needs, please consult a professional tax advisor.
* Information contained in this article merely highlight some benefits. There are risks involved with all investments that could include tax penalties and risk/loss of principal.
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