An Easy and Low-Cost Retirement Plan For Your Small Business

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1 SEP-IRA SEP-IRAs can provide a substantial source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their eligible employees. An Easy and Low-Cost Retirement Plan For Your Small Business SEP-IRAs (Simplified Employee Pensions) can provide a substantial source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their eligible employees. Under a SEP, an employer contributes directly to traditional individual retirement accounts (SEP-IRAs) for all eligible employees (including owners). A SEP does not have the start-up and operating costs of other qualified retirement plans and allows for a contribution of up to 25% of each employee s pay. Small business owners and self-employed individuals, with or without employees, may find the SEP-IRA not only to be an excellent way to save for retirement, but an easy way to reduce current taxes.

2 Your Morgan Stanley Smith Barney Financial Advisor can discuss the particulars of a SEP retirement plan with you and help you determine if it is the right plan for you and your business. SEP Tax Advantages Contributions made to SEP accounts may be considered deductible business expenses, reducing dollar-for-dollar the amount of income subject to taxes. Contributions made to a SEP have the potential to grow tax-deferred. Plan participants pay no taxes on the interest, dividends or capital gains earned by SEP contributions until they begin to withdraw funds from the plan. Distributions made before age 59½ may be subject to a 10% premature withdrawal penalty. The tax-deferral feature of the SEP provides a powerful advantage that taxable accounts just can t match. In addition, it s possible to consolidate many different retirement plans including Traditional IRAs into a SEP. Doing so may reduce fees and paperwork and will make tracking and allocating investments easier. Investment Choices in the Morgan Stanley Smith Barney SEP A SEP allows you to offer a plan that is as simple as you want, with investment choices that are as sophisticated as you need. An extensive menu of choices helps ensure that both business owners and their employees can build well-balanced portfolios suited to their individual risk tolerances and investment preferences. If you or your employees are interested in mutual fund investments,* the Morgan Stanley Smith Barney AutoVest** system will make it easy and automatic for you to invest your contributions as they are deposited into your account. You choose up to 15 mutual funds from a roster of hundreds of funds offered by dozens of investment management companies. * Investors should carefully consider the investment objectives and risks as well as charges and expenses of a mutual fund before investing. To obtain a prospectus, contact your Financial Advisor. The prospectus contains this and other information about the mutual fund. Read the prospectus carefully before investing. ** Systematic or periodic investing does not assure a profit and does not protect against loss in declining financial markets. An investor should be prepared to continue the program of investing at regular intervals, even during economic downturns. 2 SEP-IRA

3 Let Morgan Stanley Smith Barney Work With You Your Morgan Stanley Smith Barney Financial Advisor can discuss the particulars of a SEP retirement plan with you and help you determine if it is the right plan for you and your business. A good place to start your discussion may be clarifying for yourself and your Financial Advisor what your financial and retirement goals are right now. A retirement planning analysis will help you visualize the investment steps that can help make your dreams a reality, and will give you concrete information that you may apply as you establish your business s SEP retirement plan. Advantages of a SEP Contributions to a SEP can be tax-deductible, and your business pays no taxes on the earnings on the investments. You are not locked into making contributions every year. In fact, you decide each year whether or not, and how much, to contribute to your employees SEP-IRAs. Sole proprietors, partnerships, and corporations, including S corporations or limited liability companies (LLCs), can set up SEPs. Your business may be eligible for a tax credit of up to $500 per year for each of the first three years for the cost of starting the plan and educating employees about the plan. A SEP plan can be established and funded as late as the date of your final tax-filing deadline, including extensions. Contributions are made into the SEP-IRA of each eligible employee, which reduces the fiduciary responsibility associated with managing plan investments. Administrative costs are low. There is no charge to adopt the SEP. Each Morgan Stanley Smith Barney SEP-IRA account is charged $75 per year, which is not a direct cost to the employer. You should not have to file any reports with any governmental agency. Contributions to SEP-IRA Accounts As the small business owner who established the SEP, your obligation is to forward contributions to Morgan Stanley Smith Barney for those employees who meet the eligibility requirements to participate in the SEP as described in your plan document. You do not have to make contributions every year. Employee salary reduction contributions cannot be made to a SEP. However, if a plan participant is otherwise eligible they can make a deductible contribution to an IRA. At Morgan Stanley Smith Barney you can adopt a SEP that determines contributions as either: A percentage of annual compensation A percentage of compensation that is adjusted to account for the Social Security taxable wage base each year S E P - I R A 3

4 Uniform Percentage Method The simplest, and by far the most popular contribution formula, is a uniform percentage of compensation contributed across the board to all eligible employees. You determine the percentage from year to year. With this approach, your contribution for 2011 to each employee s SEP-IRA can be as much as 25% of compensation, up to a maximum dollar amount of $49,000 whichever is less. The maximum compensation that may be taken into account for this calculation is $245,000 for There are special rules if you are a self- employed (unincorporated) individual. If you contribute to your own SEP-IRA you must make a special computation to determine your maximum contribution that takes into account the deduction for one-half of your self-employment tax, and the deduction for contributions to your own SEP-IRA. You accomplish the second adjustment by reducing the contribution rate called for by the plan. A Rate Table for Self-Employed that converts the plan contribution rate to the rate for the self-employed individual is available from the Internal Revenue Service (Publication 560). DISCRETIONARY CONTRIBUTION FORMULA (10%) Incorporated Business Participant Compensation A $25,000 $2,500 B 50,000 5,000 SEP Contribution C 100,000 10,000 D 200,000 20,000 Total $37,500 For illustrative purposes only. Unincorporated Business Participant Compensation A $25,000 $2,500 B 50,000 5,000 SEP Contribution C 100,000 10,000 Owner 200,000* 17,336 Total $34,836 *Compensation is net earnings adjusted for one-half self-employment tax. 4 SEP-IRA

5 Integrated SEP The other SEP contribution election available at Morgan Stanley Smith Barney is an integrated contribution method. Under the integrated SEP, employer contributions are allocated to the SEP-IRAs using a multiple-step formula that indirectly takes into account the cap on payroll taxes paid and benefits that will be received by highly compensated individuals from Social Security. This contribution method is useful if you have employees, because it allows you to control the total cost of plan contributions while allocating a larger portion of the total contribution amount to the owners and other higher-paid employees of the business. To understand the concept of integration, it is helpful to think of Social Security as a retirement plan. Employers pay a percentage of each employee s pay into Social Security. Payments continue until an employee reaches the Social Security taxable wage base for the year. (The government may adjust the wage base annually for 2011 the wage base is $106,800.) An integrated SEP contribution formula recognizes that more highly paid employees earning over $106,800 this year will not receive any additional Social Security benefits on their earnings over the wage base. Consequently, additional contributions may be made to the SEP to compensate for this disparity. Example: Assume that an incorporated Employer elects to make a discretionary Employer contribution equalling $37,500 (10% of all Eligible Employees taxable compensation) for the plan year and to allocate the contributions using the integrated method. Using the Social Security taxable wage base of $106,800, the contributions would be allocated as shown in the example below. DISCRETIONARY INTEGRATED CONTRIBUTION FORMULA Eligible Employee Compensation Step 1 Step 2 Step 3 Step 4 Total A $25, = 2,146 B $50,000 1, , ,442 = 4,292 C $100,000 3, , ,883 = 8,583 D $200,000 6, , , ,767 = 22,479 Total $375,000 11,250 2,796 12,641 10,813 = 37,500 Note that the Social Security taxable wage base generally increases each year and any such increase will affect your allocation Social Security Wage Base is $106,800. For illustrative purposes only. SEP-IRA 5

6 Distributions Participants cannot take loans from their SEP-IRA. However, since contributions are 100% vested when deposited participants can make withdrawals at any time, subject to the limits discussed below. Withdrawals can be rolled over tax-free to another SEP or traditional IRA, or to another employer s qualified retirement plan, if allowed by the other plan. Withdrawals from a SEP that are not rolled over to another plan are subject to income tax for the year in which the employee receives the distribution. If an employee withdraws money from a SEP before age 59½, a 10% premature distribution tax is due in addition to regular income tax unless an exception applies. Several specific exclusions, including disability or qualified education expenses, would be exempt from the penalty. As with other traditional IRAs, participants in a SEP must begin withdrawing a specific minimum amount from their accounts by April 1 of the year following the year the participant reaches age 70½. Each year following the year the participant reaches age 70½, an additional Required Minimum Distribution must be distributed by December 31. Morgan Stanley Smith Barney will notify the participant by January 31 of each year what the Required Minimum Distribution amount is for the current year. All participants must receive these annual withdrawals, regardless of whether or not they are working at age 70½. Failure to comply will result in a 50% penalty of the amount that should have been withdrawn, but wasn t. 6 SEP-IRA

7 Establishing the SEP Step 1: Your Morgan Stanley Smith Barney Financial Advisor will provide you with a SEP-IRA custodial agreement. A SEP may be established as late as the due date (including extensions) of the company s income tax return for the year you want to establish the plan. For example, if your business s fiscal year ends on December 31 and you filed for an automatic six-month extension, the company s tax return for the year ending December 31, 2010 is September 15, 2011, allowing you to establish and make the initial SEP contribution no later than September 15, Step 2: Complete and sign the SEP custodial agreement. This agreement becomes the plan s basic legal document, describing the features of the plan. Do not send it to the IRS; instead, use it as a reference since it sets out the plan s terms (e.g., eligible employees, includable compensation, and employer contributions). Step 3: Give your employees a copy of the SEP agreement and disclosure statement as well as an IRA Application for each eligible employee to complete and sign. That will establish the account where employer contributions will be deposited for that employee. Step 4: Send copies of the SEP Agreement and all the employees IRA Applications to your Morgan Stanley Smith Barney Financial Advisor. Employee An employee is not only someone who works for you, but also may be a selfemployed person as well as an owner-employee who has earned income. In other words, you can contribute to a SEP-IRA on your own behalf. Eligible Employee Is at least 21 years old, and Has performed service for you in at least three of the last five years. All eligible employees must participate in the plan, including part-time employees, seasonal employees, and employees who die or terminate employment during the year without regard to the number of hours worked. Your business has the option of excluding the following categories of employees: Employees covered by a union contract nonresident alien employees who did not earn U.S. source income from you Employees who received less than $500 in compensation during the year (subject to cost-ofliving-adjustments) SEP-IRA 7

8 Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC, its affiliates, and Morgan Stanley Smith Barney Financial Advisors do not provide tax or legal advice and are not fiduciaries (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise agreed to in writing by Morgan Stanley Smith Barney. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their tax or legal advisors before engaging in any transaction involving SEP IRAs, SIMPLE IRAs, SAR-SEP IRAs or other tax-advantaged investment vehicles Morgan Stanley Smith Barney LLC. Member SIPC KP /10