Retirement Plans

By Gregory J. Cook, EA, CPA, Accredited Tax Advisor

A tax-qualified retirement plan offers employees an attractive means of saving for retirement and is an effective way for employers to get tax deductions and possible credits. Unfortunately, small businesses don't always offer their employees any retirement plan at all due to the common misconception that such plans come with high costs and heavy administrative demands. Instead, employers may encourage their employees to establish Individual Retirement Accounts (IRAs).

But IRAs alone aren't always enough to help these employees retire comfortably, and small businesses are in danger of losing employees to larger businesses which offer more attractive benefits packages.
In order to attract and retain valuable employees, many small businesses may want to consider offering employees a Simplified Employee Pension (SEP IRA), SIMPLE IRA or Profit Sharing Plan. These plans are relatively simple for the employer to establish and operate, and they need not overextend the resources of a small business. Beginning in 2002, small businesses that adopt a new plan may be eligible to receive up to a $500 credit for administrative and retirement education expenses. The credit is available for plan expenses (including retirement education) incurred for the first three plan years. Employees enjoy a vehicle for tax-deferred growth of assets and are provided with a tool to help them achieve retirement security.

The Simplified Employee Pension IRA, or SEP IRA, is very popular in the small business community because employer contributions are fully discretionary each year, and employers may take a tax deduction for the amount contributed on behalf of each employee. The contribution, if any, is not taxable to the participants until withdrawn. The self-directed SEP IRA offers employees the ability to accumulate more assets than possible through a Traditional IRA and to choose investments that meet their specific retirement needs.
The SIMPLE IRA, designed for companies with 100 or fewer employees, is a salary deferral plan structured to eliminate many of the complex administrative requirements often associated with 401(k) plans. The SIMPLE plan allows for employee salary deferral contributions of up to the lesser of $7,000 (for 2002) or earned income, made on a pre-tax basis. The required employer contribution can take the form of either a 3% match or a 2% non-elective contribution. While the burden of funding the plan is shared by employer and employee, the employer gets a tax deduction for the entire amount contributed on behalf of each employee. Investment earnings accumulate tax-deferred until distributed from the plan.

Beginning in 2002, individuals who have reached age 50 by the end of the plan year are allowed a "catch-up" contribution to their SIMPLE IRA account. An additional $500 (for 2002) may be deferred into their account once the $7,000 limit has been reached. This additional amount will increase in $500 increments until it reaches $2,500 in 2006, to be indexed for inflation thereafter.

The Profit Sharing Plan is a qualified retirement plan that allows for discretionary tax-deductible contributions of up to 25% of total compensation paid to all eligible employees. Annual contributions on behalf of any individual can be up to the lesser of 100% of eligible compensation or $40,000 (indexed for inflation). All contributions are made by the employer and the percentage contributed can vary from year to year. With this plan, the employer retains the flexibility of excluding some part-time workers while the employee enjoys an employer-funded benefit plan that offers the possibility to accumulate significantly more assets on a tax-deferred basis than through a Traditional IRA.

As you can see, there are many options for small business owners looking to provide a tax-deferred, employer-sponsored qualified plan. By establishing a retirement plan, you can effect a dramatic difference in tomorrow's standard of living for yourself and your employees.