Hiring Employees
Employee Pension/Retirement Plans
Retirement plans are savings plans that offer
you tax advantages to set aside money for your and your employees'
retirement.
SEP, SIMPLE and qualified plans offer you
and your employees a tax favored way to save for retirement. You
can deduct contributions you make to the plan for you and your
employees. The contributions and earnings are generally tax free
until you or your employees receive distributions from the plan
in later years.
In general, individuals who are employed can
also set up and contribute to individual retirement arrangements
(IRAs).
All retirement plans have important tax, business
and other implications for employers and employees. Therefore,
you may want to discuss any retirement savings plan with a tax
or financial advisor.
Visit the IRS
web site for more information on retirement plans
Simplified
Employee Pension (SEP)
A Simplified Employee Pension (SEP) is a written
plan that allows you to make contributions toward your own and
your employees' retirement without getting involved in a more
complex qualified plan. Under a SEP, you make the contributions
to an individual retirement arrangement (called a SEP-IRA) set
up for each eligible employee. SEP-IRAs are owned and controlled
by the employee, and you make contributions to the financial institution
where the SEP-IRA is maintained. You generally do not have to
file annual retirement plan information reports with the government.
Under a SEP, you must contribute a uniform
percentage of pay to each eligible employee's SEP-IRA. You are
not locked into making contributions every year. You can decide
how much to put into a SEP each year - offering you some flexibility
when business conditions vary. Employer contributions are limited
to the lesser of 15 percent of an employee's annual salary or
$25,500. (Note: this amount is indexed for inflation and will
vary).
You can set up a SEP by completing an IRS
model SEP using Form
5305-SEP. See the instructions to the form for exceptions.
No IRS approval is required. Keep the original form. Follow its
terms and instructions. Do not file it with the IRS. You must
also set up a SEP-IRA for each eligible employee. SEP-IRAs can
be set up with banks, insurance companies, or other qualified
financial institutions. You send SEP contributions to the financial
institution where the SEP-IRA is maintained.
You can set up a SEP for a year as late as
the due date (including extensions of your income tax return for
that year.
Contribution
limits.
Deduction
limits.
Reporting
SEP Contributions of Form W-2.
Form 5305-SEP
SIMPLE
Plan
A Savings Incentive Match Plan for Employees
(SIMPLE) allows employees to contribute a percentage of their
salary each pay check. Under a SIMPLE, employees can set aside
up to $6,000 each year by payroll deduction. Employers can either
match employee contributions dollar for dollar - up to 3 percent
of an employee's wage - or make a fixed contribution of 2 percent
of pay for all eligible employees instead of a matching contribution.
You can set up a SIMPLE only if you had 100
or fewer employees who earned $5,000 or more in compensation during
the preceding year. You cannot sponsor a SIMPLE if you currently
sponsor another plan.
You can use 5304-SIMPLE
or Form
5305-SIMPLE to set up a SIMPLE. Each form is a model SIMPLE
document. Which form you use depends on whether you select the
financial institution or your employees select the financial institution
that will receive the contributions. Use Form 5304-SIMPLE if you
allow each plan participant to select the financial institution
for receiving his or her SIMPLE contributions. Use Form 5305-SIMPLE
if you require that all contributions under the SIMPLE be deposited
initially at a designated financial institution.
A SIMPLE is adopted when you have completed
all appropriate boxes and blanks on the form and you have signed
it. No IRS approval is required. Keep the original form. Follow
its terms and instructions. Do not file it with the IRS. You generally
do not have to file annual retirement plan information reports
with the government.
A SIMPLE IRA must be set up for each eligible
employee. A SIMPLE IRA is the individual retirement account or
annuity into which the SIMPLE contributions are deposited. Form
5305-S and Form 5305-SA are model trust and custodial account
documents that the participant and the trustee (or custodian)
can use to set up a SIMPLE IRA.
Definitions
Contribution
Limits
Qualified
Plans (Keogh Plans)
Qualified plans offer higher contribution limits and greater flexibility
than SEPs and SIMPLEs. However, they are also more complex and
difficult to operate. They generally involve an annual information
reporting requirement. See Form 5500 and Form 5500-EZ. Although
advance IRS approval is not required, you can apply for approval
by paying a fee and requesting a determination letter. See Revenue
Procedure 2001-6 and Form
5300 or
Form 5307.
There are two basic kinds of qualified plans
-- defined contribution plans and defined benefit plans -- and
different rules apply to each. A defined contribution plan provides
an individual account for each participant in the plan. It provides
benefits to a participant largely based on the amount contributed
to that participant's account. Benefits are also affected by any
income, expenses, gains, losses, and forfeitures of other accounts
that may be allocated to an account.
Profit-sharing plans and money purchase pension plans are types
of defined contribution plans. A profit-sharing plan is a plan
for sharing your business profits with your employees. Contributions
to a money purchase pension plan are fixed and not based upon
your business profits.
In a profit-sharing plan, the contribution
formula can be flexible and you do not have to make contributions
out of net profits to have a profit-sharing plan. A profit-sharing
plan can also contain a cash or deferred arrangement - also known
as a 401(k) plan - a plan that allows employees to contribute
a percentage of their salary each pay check. You can contribute
to your employee's 401(k) account by matching the amount of pay
that your employees have deferred into the 401(k) plan, usually
up to a percentage of the employee's pay.
Defined benefit plans promise a specified
benefit at retirement, for example, $100 a month at retirement.
The amount of the benefit is often based on a set percentage of
pay multiplied by the number of years the employee worked for
the employer offering the plan. Employer contributions must be
sufficient to fund the promised benefit. Actuarial assumptions
and computations are required to figure these contributions. Generally,
you will need continuing professional help to have a defined benefit
plan.
Most qualified plans follow a standard form
of plan (a master or prototype plan) approved by the IRS. Master
or prototype plans are made available by plan providers for adoption
by employers (including self-employed individuals). Under a master
plan, a single trust or custodial account is established, as part
of the plan, for the joint use of all adopting employers. Under
a prototype plan, a separate trust or custodial account is established
for each employer. A master or prototype plan can generally be
obtained from one of the following organizations: banks (including
some savings and loan associations and federally insured credit
unions), trade or professional organizations, insurance companies
and mutual funds.
Kinds
of Qualified Plans
Plan
Approval
Deduction
Limits
Individual
Retirement Arrangements
An individual retirement account (IRA) is a personal savings plan
that allows you set aside money for your retirement. Even if you
do not want to adopt a retirement plan, you can allow your employees
to save for retirement through payroll deduction, providing a
simple and direct way for employees to contribute to an IRA. You
do not have to set up IRAs for your employees or make contributions
for them. There are various tax advantages to IRAs depending on
the type of IRA and the circumstances. For more information on
IRAs, see Publication
590.
Which Plan is Right for Your Business?
There are many factors to consider when deciding
which plan best fits your business. When determining which plan
is right for you, consult a financial advisor. Also, see Select
a Retirement Plan web site for additional information.
Important References
Publication
535
Business Expenses
Form
5300
Form 5307
Form
5305-S
Form 5305-SA
Form
5304-SIMPLE
Form 5305-SIMPLE
Form 5500
Form 5500-EZ
Form
5305-SEP
Simplified Employee Pension-Individual Retirement Accounts Contribution
Agreement
Form
1040 Schedule C Profit or Loss
From Business
Form
1040 Schedule F Profit or Loss
From Farming
Form
1065
U.S. Partnership Tax Return
Publication
560
Retirement Plans for the Self-Employed
Publication
590 Individual
Retirement Arrangements
