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SIMPLE and SEP IRAs: Retirement Plans for Small Business

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According to the Small Business Administration, small businesses make up almost half of private-sector employment.  To help support this group, the IRS and the Department of Labor developed retirement plans specifically for use by small businesses and their employees.  In today’s post, we’ll get you up to speed on the popular SIMPLE IRA and SEP IRA retirement plans.

SIMPLE IRA plans allow employees to contribute up to $11,500 to their account in 2013.  In addition, employees over age 50 are allowed catch-up contributions of $2,500 per year.  Employee contributions are considered salary reductions and reduce taxable income at both the federal and state level.  Plan participants must be 59 ½ before taking distributions to avoid early withdrawal penalties.  Required minimum distribution rules apply at age 70 ½.  Employers are allowed to choose one of the following matching contribution programs:

  • 2% non-elective – Every eligible employee receives 2% of their salary as a contribution to the plan, regardless of whether or not the employee contributes.
  • 3% match – The employer must match an employee’s contributions dollar-for-dollar, up to a maximum of 3% of their salary.  The employer can reduce this match to as low as a 1%, but only for two out of the previous five years.

Key characteristics of SIMPLE IRA plans include:

  • Early distribution penalty – If an employee makes a withdrawal in the first two years of participating in the plan, the penalty is 25%, which is much steeper than the 10% penalty for most retirement plans.  This two year rule applies to tax-free rollovers as well.
  • Distribution limitations – Since a SIMPLE is an IRA based plan, distributions can be made at any time while still employed, without a hardship reason or employer approval.
  • Loans –SIMPLE IRAs do not allow loans.  However, monies could be withdrawn and replaced within 60 days once per year without penalty.
  • Rollovers – SIMPLE IRAs cannot receive rollovers from other types of plans, except from other SIMPLE IRAs.  They can, however, be rolled into most other types of plans, such as IRAs and 401(k) plans.

SEP stands for “simplified employee pension.”  The most unique feature of a SEP IRA is that contributions are made to the plan solely by the employer.  Employees don’t have the option to contribute to their accounts.  Employers have the flexibility to decide on an annual basis how much they are going to contribute, and those deposits are usually allocated to the employees based on a percentage of their income, or by another IRS approved formula.  SEP IRA plans limit contributions to 25% of employee compensation, or 20% of self-employed earnings, with a maximum of $51,000 for 2013.  SEP IRAs don’t allow loans, and distributions can be taken without employer approval.  The early withdrawal penalty is only 10%, and they can generally be rolled into any other type of qualified plan.  These plans tend to be popular with self-employed workers, as the contribution cap is more than the $5,500 that traditional IRAs allow.

Both SEP plans and SIMPLE plans have special rules when it comes to plan setup.  Make sure to consult a Certified Financial Planner™ professional if you have questions regarding either one of these unique retirement plans.

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