Should I Establish A SEP IRA Or A SIMPLE IRA Plan For My Small Business?
Updated: 23 hours ago
Our business owner clients may be searching for retirement plan options that benefit their employees and themselves, without incurring burdensome costs or administrative complexity. SEP and SIMPLE IRAs can be great alternatives to 401(k)s, each offering attributes that could be attractive, depending upon your client’s specific circumstances. Comparing these two options can be difficult, as there are multiple factors to weigh.
To help you lead our clients through a SEP vs. SIMPLE IRA analysis, we have created this flowchart. Through a series of decision points, we can collect the information necessary to guide our clients to the best decision. It covers pertinent factors, including:
Business owner goals and preferences
Size of business/employee headcount
Employer and employee ability to contribute
Contribution minimums and limits
Hi, Todd Pouliot, Gateway Financial. Thanks again for coming back. Feel free to visit us at www.mygatewaymoney.com. In today's video we're going to talk about two things. We're going to talk about SIMPLE and SEP IRAs. And, I know the big one is 401k, but we're going to push that off to the side today and talk about small business retirement planning. So, our business owner clients may be searching for a retirement plan opportunity that benefits their employees as well as themselves without incurring the burdensome cost or administration complexity. So, SEP and SIMPLE IRAs can be great alternatives to 401ks. Each offers attributes that could be attractive depending on your situation and circumstances. And, comparing these two options can be rather difficult and there are multiple factors to weigh. So, we've created this flow chart here that helps guide us through that SEP and SIMPLE IRA analysis it's a series of decision points and we want to collect the information necessary to guide our clients through the best decision. It covers pertinent factors such as business owner goals and preferences, size of the business and employee headcount, and employer and employee ability to contribute. Sometimes I refer to those as ee or er. And again, contribution minimums and limits. So, I'm going to go ahead and do what we always do and share our screen and show you what we're talking about. And again, specific to SEP and SIMPLE and we're not going to get into all the data points, contribution limits, and details but this will be a beginner's guide to help you say, “Hey, this is the direction I want to go down before I learn all the nitty gritty.” So, do you have more than a hundred employees who have earned more than 5,000 a year each in the last year? Well yes. Well, then you're automatically put into that SEP IRA. You cannot do a SIMPLE plan for more than 100 employees. SIMPLE is what it sounds like. It is simple and it's meant for a small employee number count. So, we want to make sure that we head in that direction. I will tell you, I have personally never seen a SEP IRA more than 20. So, once you've hit this employee count, just understand you're probably not talking about either of these. You are probably talking about a 401k but understand, legally that you are eliminated from a SIMPLE plan with over 100 employees. So obviously, if the answer is no, do you want to allow employee contributions? And again, I try to put emphasis on e versus r. So, no, I don't want employee contributions. Consider a SEP IRA. It is only employer contributions. Literally had a phone call about this today where somebody called and they were making a contribution over the IRA allotment or allowable amount this year. And I said, “Well that's obviously the employer, not an employee because it's a SEP contribution which can only be an employer contribution.” So, it's funny when you talk to people they really don't know what the differences are. If you do want employee contributions, consider a SIMPLE. It allows deferrals up to the lesser of a hundred percent of their salary or fourteen thousand dollars. Seventeen thousand if you're over age fifty in addition to employer contributions. So, that's a pretty good number. We don't see a lot of small employers or micro employers with a lot of very high contribution amounts or average account contributions. So, we want to look at that amount. Is that kind of where we'd like to be? And sometimes, I don't even see the employer contributing enough, they're trying to put money back into the business. So, this may be a good alternative to a 401k plan. So, we're going to slide over here. “Are you willing to make and able to make regular annual contributions to employee’s accounts?” Again, able to make it, yes. Consider the SIMPLE IRA, it requires an employer to either make a non-elective contribution. Again, non-elective two percent to an employee’s salary or to match employee deferrals up to three percent of such employee's salary or one percent in two of the prior five years. Be careful when you're talking about this. This is free money to the employee so as the employer you want to say, “Do I want to help out those who are helping out themselves?” That's the three percent or do you want to kind of safe harbor that and take all of that away and make everybody even and say, “I'm making a non-elective two percent contribution to everybody equally at that two percent of salary or income or whatever they earned that year if they're an hourly employee. If no, consider a SEP. I can't – I'm not sure what each and every year brings. Consider a SEP IRA. It does not require an employer to make any minimal annual contributions. However, any contribution must be made equally to eligible employees, so be very aware that if you have a banner year in your small micro business and you want to make a very large contribution to yourself, as the owner because you're on the payroll, you're going to be making a very large contribution to each and every one. So, that's why we don't see very large SEP IRA employers or companies with a lot of employees because those numbers can get out of hand very fast. Let's assume your business has grown by 300 percent in one quarter because you've had a banner year, that could be extremely costly for you. And, do you want to maximize the potential total annual funding of accounts? Boy, I certainly do. I want to maximize my contributions. Consider a SEP IRA which will allow employer contributions up to the lesser of 25 percent of an employee's salary or 61,000 dollars per year. That's a fantastic number. That you – that's a number you cannot have inside of a 401k. So, I’m a small business owner, I might be the only employee or it's just me and my spouse or it's me and my best friend, or whatever your small group is for that business, you can save so much more than you could save in a traditional 401k and that's where that SEP plan seems to shine. And again, there are a lot of other plans and I will be making a video on other small business plans; cash balance plans, defined contribution, and 401k plans, but we're just talking about two very easy plans to understand. Do you want to minimize the number of plan participants? This is sometimes called a carve-out. “I don't want everybody in this plan.” Have your employees tended to be seasonal, part-time, and/or short-term? Let's say that answer is no. Consider a SIMPLE plan, which must be offered only to those employees who have compensation of at least $5,000 in either the prior two years and are expected to earn at least $5,000 from your business this year. That takes care of all your temporary workers that come in or somebody that might just be an intern for a little while. You can carve out some of those. And, if they are part-time, consider the SEP, and those are only available to those age 21 or older and have worked for you in three of the last five years. So, those are some issues that you want to look at is, “Maybe I don't want to be contributing to everybody.” And, that may change your decision on SEP versus SIMPLE. And, back over here, I don't really care about minimizing. And, is it possible that withdrawals must be needed within your first two years of participation in the plan? Yes, we may need some withdrawals. Consider a SEP because withdrawals from the first two years from a SIMPLE are subject to an early withdrawal penalty of 25 percent instead of 10 percent for a SEP when taken before age 59 and a half. And again, there are some exceptions to that rule. But that's a strong penalty on top of your normal income tax rate. So, the a huge penalty for drawing earlier. And, if it's a no, well note that neither a SEP IRA nor a SIMPLE IRA allows loans. That's something that some people don't really think about. “What do you mean, I can't get a loan for this or for that?” That's a really strong way to consider a 401k plan. For a 401k plan, I am not a proponent of loans inside of the plan document however, there are always hardship withdrawals. So, be careful that you know, what plan you choose today, you will have hopefully, several years but also allow yourself to pivot. And, they do not affect your contribution limit for Roth or traditional IRA but may affect the deductibility later. Again, that's why you always hear me tout, “Make sure you're working with a really good accountant like we have here at our office, and make sure you understand the tax planning strategies.” So hopefully, I taught you a little bit of something today that's a little different. 401k plans are fantastic plans how they are originally designed and the costs have greatly reduced with the amount of technology that we have today in automation. They're much much easier to operate today with our 401k plans with employers. And, SEP and SIMPLE are even less costly if you can get them done right. But I will tell you, there are 401k plan offerings that are out there that we could help you with that might be just as inexpensive. And, I don't use the word cheap, I just mean inexpensive because you want to keep those costs and fees down not only for yourself as a business owner, but also as an employee of that business to do what's right by your employees. Ultimately I think the goal of these plans is to help people retire with dignity and stay retired with dignity. So, really look strongly at what those options are. I'm just showing you two today the SEP and the SIMPLE and we'll bring you more videos about 401ks, defined contributions, 403bs, and a lot of the other plans that are out there available for retirement. But again, thank you so much to our subscribers, please hit those thumbs up we really need those subscribers to stay with us and share our message. We're trying to bring you education at your level and we're trying to help teach people about finances and all the things that are out there. And, we're closing up on video 50 here and we appreciate you guys being along for the ride with you – with us. Thanks, and have a great day.