RETIREMENT PLAN OPTIONS FOR SMALL- TO MID-SIZE BUSINESSES

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1 RETIREMENT PLAN OPTIONS FOR SMALL- TO MID-SIZE BUSINESSES David Eisenman HMWC CPAs & Business Advisors Doug Jones Creative Retirement Solutions, LLC NON-QUALIFIED RETIREMENT PLANS SIMPLE AND SEP PLANS Difference between Qualified and Non-Qualified Plans o To qualify for the tax benefits available to qualified plans, a plan must meet certain requirements (qualification rules) of the tax law. Non-Qualified plans don t. The two popular types of non-qualified plans are SIMPLE Plans and SEP Plans Seminar 1

2 SIMPLE PLANS SIMPLE Plans (Savings Incentive Match Plan for Employees of Small Employers) o This is a retirement plan that has a SIMPLE IRA set up for each employee, in either their own financial institution or one that you choose for them. It is set up by filling out Form 5304-SIMPLE or 5305-SIMPLE Who can set up a SIMPLE Plan? o Must not maintain another qualified plan and have 100 or fewer employees. The SIMPLE IRA plan is adopted when you have completed all appropriate boxes and blanks on the form and the owner (and potentially a financial institution) has signed it. The form does not have to be filed with the IRS. SIMPLE PLANS When can you set up a SIMPLE Plan? o A SIMPLE IRA plan can be set up by October 1 of the current year provided you did not previously maintain a SIMPLE IRA plan. A SIMPLE IRA must be set up for each employee. This must be done before the first date a contribution is required to be deposited into the employee s IRA. Seminar 2

3 CONTRIBUTION LIMITS TO A SIMPLE PLAN o Contributions are made up of salary reduction contributions and employer contributions. The employer must make either matching contributions or non-elective contributions o The employee can choose to contribute to a SIMPLE IRA up to $11,500 for 2012 expressed as either a percentage of the employee s compensation or as a specific dollar amount. The employer cannot place any other limits on the contribution amount. Catch-up contributions of an additional $2,500 can also be made by employees who are age 50 or over. These employee contributions must be contributed to the SIMPLE IRA within 30 days after the end of the month that the related salary was paid. EMPLOYER CONTRIBUTIONS o Employers must choose to either match each employee s salary contribution or make a non-elective contribution to the employee s account. Employer contributions must be made by the due date for the business tax return including extensions. o Generally, the employer match must be dollar for dollar of the employee s contribution up to 3% of the employee s salary. This is the default contribution. The employer can choose either e a 1% or 2% contribution o for two years out of any five years. If a lower contribution is chosen for any given year, then the employees must be notified in a reasonable amount of time prior to November 1 of the current year. Seminar 3

4 EMPLOYER CONTRIBUTIONS o Instead of the matching contributions, the employer can choose to make non-elective contributions of 2% of compensation on behalf of each eligible employee who has at least $5,000 of salary for the year. The contribution tio must be made whether or not the employee chose to make a salary reduction contribution. Only salary up to $250,000 must be considered for this calculation. This choice must be made by the employer within a reasonable amount of time prior to November 1 of the current year. Things to Know o The employee must begin to receive distributions from a SIMPLE IRA after the employee reaches age 70 ½. Early withdrawals by employees are subject to a 10% additional tax, but this tax is increased to 25% if funds are withdrawn within 2 years of beginning participation. o There is also a SIMPLE 401k plan, however this is considered a qualified retirement plan and is subject to the qualification rules. Seminar 4

5 SIMPLE PLAN EXAMPLE o There is a small company where the owner makes $150,000 per year and has one employee who is paid $40,000 per year. The employer s salary reduction contribution is $10, and the employee s ee is $2,000. The default employer contribution would be $5,700, 3% of each the $150,000 and $40,000. If the employee only contributed $500 in salary reduction, then $5,000 ($4,500 + $500) would be the maximum amount of the employer contribution for that year. o In the original example, twice every five years, the employer can limit the match to 1% of salary which would be $1,900 total. And in any year, you can pay the nonelective contribution which is 2% of all eligible salaries, which in this case would be $3,800. SEP (Simple Employee Pension) o A SEP is a written plan that allows you to make contributions toward your own retirement and your employees retirement without getting involved in a more complex qualified plan. It is set up by filling out Form 5305-SEP SEP. Setting-Up a SEP o There are a few restrictions on employers for setting up a SEP. Each employee must be given certain information about the SEP and a SEP-IRA must be set up for each eligible employee at a financial institution. An eligible employee is one who has reached age 21, has worked for you in at least three of the last 5 years and has at least $550 of compensation for the year. The deadline for setting up a SEP is the due date plus extensions of your income tax return. Seminar 5

6 Contribution to a SEP o Employers contribute a limited amount of money each year to each employee s SEP-IRA. Contributions do not have to be made every year. Contributions must be based on a written allocation formula and must not discriminate in favor of highly compensated employees. Contributions must be made to all eligible employees who performed services during the year. SEP contributions must be made by the due date of the employer s tax return including extensions. Contribution Limits to a SEP o o Contributions to a SEP-IRA for an employee cannot exceed the less of 25% of the employee s salary or $50,000. Compensation considered for a SEP contribution cannot exceed $250,000. The SEP plan document will specify how the employer contribution is determined and how it will be allocated to employees. An employer does not have to make a contribution in any given year. Contributions for self employed individuals are limited to your net earnings from self-employment which takes into account the deduction for the deductible part of your self-employment tax and the deduction for contributions to your own SEP-IRA. Things to Know o Employees must begin to receive distributions from a SEP IRA after the employee reaches the age 70 ½. Early withdrawals are subject to a 10% penalty. Sole proprietors and partners can t deduct as a business expense contributions made to a SEP for themselves, only those made for their employees. SEP Example o There is a small company, where the owner makes $150,000 per year, and has one eligible employee who is paid $40,000 per year. The owner would like to put as much away as possible into his SEP IRA so the maximum he can contribute for himself is $37,500 ($150,000 x 25%). But, in order to do this, he will need to contribute $10, ($40,000 x 25%) for his employee. If he would like to limit the contribution to his employee to a $2,000 contribution, he would only be able to contribute $7,500 ($150,000 x 5%) for himself. Seminar 6

7 FUNDAMENTAL CONCEPTS Qualified Plans under IRC 401(a) versus IRA type plans o Qualified plans offer: o Greater contribution limits o Greater design flexibility o Provision for loans o Greater asset protection o Qualified Plan must be sponsored by a business entity FUNDAMENTAL CONCEPTS o Form of business organization is largely irrelevant C-corps, S-corps, Partnerships, LLCs, Sole Proprietorships, Sub S (only consider W-2 wages) o Any size business can have a Qualified Plan o All employees of business must be considered in plan design o Common ownership of other businesses must be considered in plan design Seminar 7

8 FUNDAMENTAL CONCEPTS o All employer contributions to qualified plans are fully tax deductible to the business o Generally a tax return due for Qualified Plans o Accounts grow tax free; but taxable as ordinary income when withdrawn (unless rolled over) o Portability of accounts upon termination of employment TWO TYPES OF QUALIFIED PLANS 1. Defined Benefit Plans (DB) Defines the benefit which will be payable at retirement age o Expressed as a monthly or annual annuity benefit o Participant gets the promised benefit at retirement o Payable over participant s entire lifetime 2. Defined Contribution Plans (DC) Defines the contribution that goes into the plan today o Participant gets whatever amount has accumulated in the account. Seminar 8

9 DEFINED BENEFIT PLANS o Traditional DB plans and newer Cash Balance Plans o Promises a benefit at retirement Usually based on a formula using compensation and/or length of service Actuary determines the amount needed at retirement age to pay lifetime annuity o Two sources of money to pay the promised benefit: 1.) Employer Contributions and 2.) Investment Gains o Implies DB plans are often invested more conservatively ADVANTAGES OF DB PLANS o Much larger annual contributions per person than in DC plans $100,000 - $200,000 per person versus DC $50,000 Age based contribution o No deduction limit on contributions Seminar 9

10 DISADVANTAGES OF DB PLANS o Less contribution flexibility; actuary must calculate the contribution o Employer contributions can be affected by swings in investments o More costly to administer o Annual benefit increase are typically earned by June; less planning time for sponsor o Not easily understood by employees o May require insurance by Pension Benefit Guaranty Corporation Exempted professional service under 25 eligible, owner only DEFINED CONTRIBUTION PLANS (DC) o Two most popular: 1.) Profit Sharing Plans and 2.) 401(k) Plans o Most popular plan types o No promised benefit at retirement age; just whatever is in account o Annual allocation/contribution limit per person $50,000 (indexed) o Deduction limit for the business 25% of eligible pay Seminar 10

11 DEFINED CONTRIBUTION PLANS (DC) o Advantages of DC plans: Much greater flexibility on contributions ti from year to year Simplest and most easily understood by employees Less costly to administer o Disadvantage of DC plans: Lower contribution limits PROFIT SHARING PLANS o Simplest plan type combines great flexibility with lowest admin costs o Only one source of money employer contributions o Employer has complete discretion on contribution amount each year 0 to 25% of pay Substantial & recurring requirement over time o Annual allocation/contribution limit per person - $50,000 Includes only contributions and forfeitures Seminar 11

12 PROFIT SHARING PLANS o Three primary methods of allocating company contributions Pro Rata based on compensation Permitted Disparity Cross Tested (New Comparability) Subject to testing, can give higher benefits to one or more select employees Uses age as an allocation factor, favoring older employees o Eligibility requirements of up to 1 year & age 21; 2 years if 100% vested o Generally all plan assets are invested on a pooled basis by a plan committee 401(K) PLANS o Most popular: employee decides how much to save; and most often how to invest o Considered vital by many businesses today to attract & retain good employees o Is a Profit Sharing Plan with all the attributes already noted? But with 3 potential sources of money: Employee 401(k) contributions through payroll Employer matching contributions Employer profit sharing contributions o Annual allocation/contribution limit is still $50,000 per person Includes employee, match, profit sharing and any forfeitures Catch up contributions are not included in $50,000 limit Seminar 12

13 401 (K) PLANS o Employee traditional 401(k) contributions Calendar year limit: $17,000 for 2012 (indexed) Catch Up contributions If age 50 or older; or turn age 50 by end of calendar year Additional contribution limit of $5,500 (indexed) Gives total 401(k) limit of $22,500 Gives total Plan limit of $55,500 Traditional 401(k) contribution is pre tax ; (but still subject to FICA & Medi) Grows tax free; ultimately taxable as ordinary income when withdrawn 401(K) PLANS o Plan can also allow Roth 401(k) contributions Roth 401(k) contributions are after tax contributions All Roth contributions ultimately distributed tax free Investment gains on Roth contributions may be distributed tax free Distributed after 59.5, or upon death or disability More than 5 years after first Roth 401(k) contribution o Employee 401(k) contributions subject to special Qualification Test Highly Compensated versus Other Employees Ensures HCEs do not take undue advantage of the plan compared to Others Difficult test for many employers Seminar 13

14 401(K) PLANS o Safe Harbor 401(k) Plans Automatically passes special Qualification Test Two alternative employer contribution requirements to be Safe Harbor Match: 100% on first 3.0% contributed, then 50% on next 2.0% Only to employees who make a 401(k) contribution Profit Sharing: 3.0% of pay contribution for all eligible employees Either Safe Harbor contribution must be 100% vested Annual Safe Harbor notice requirement to employees o Automatic Enrollment 401(k) Plans Newly eligible employees must opt out; instead of traditional opt in Helps some plans pass the Qualification Test DESIGN CONSIDERATIONS o Employer objective employer benefit vs. employee benefit o Personal objective or business owner o Employer contribution amount, if any o Employee population demographics age, education, salary levels o Combination of DB and 401(k) plan can be very effective benefit for owner Seminar 14

15 PLAN SET UP ANDON GOING REQUIREMENTS o Written plan document is required o IRS approval or pre-approved document o Tax EIN for Plan Trust, with designated Trust account(s) o Annual administration, compliance testing, participant reporting, tax return COMMON PLAN FAILURES / ISSUES o 401(k) Qualification Test o Top Heavy o Controlled Group or Affiliated Service issues Seminar 15

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