- Self-Directed Accounts
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Self-Directed IRA Concepts
As your small business grows, it’s time to start thinking about the kinds of financial benefits you’d like to offer your employees. While you want to offer your employees the safety and security of a retirement plan, it can be difficult to understand what you can afford and what options require the least amount of work, maintenance, and expense.
We broke down the two main plans, SEP and SIMPLE IRAs, to explain the advantages, who qualifies, and provide examples. Some of the main differences to consider when choosing a plan are how many people your company employs, contribution limits and whether employees contribute (SEP IRA plans only allow the employer to make contributions to the account whereas a SIMPLE IRA allows more employee control).
[Related post: Differences between a Roth and Traditional IRA]
Summary: A Simplified Employee Pension (SEP or SEP IRA) is designed for self-employed individuals or small businesses with fewer than 25 employees. If you earn a self-employment income, you are allowed to save more for retirement using a SEP plan than a traditional IRA or Roth allows.
Self-employed people or small businesses with fewer than 25 employees. The SEP allows for pre-tax contributions toward retirement without getting involved in a more complex qualified plan such as a 401(k). Contributions to a SEP are tax-deductible and compound tax-deferred until withdrawn, pending that the distribution is taken after the account holder reaches 59 1/2 years of age. Additional information related to SEP accounts can be found on the IRS website.
The IRS tells us who can participate in a SEP. The employee:
An employer can use less-restrictive participation requirements than those listed, but not more restrictive ones.
The IRS states that employers’ contributions cannot exceed the lesser of:
Here are examples from the IRS to help demonstrate when a SEP is a good choice:
Example 1: Employer X maintains a calendar year SEP. The eligibility requirements under the SEP are: An employee must perform service in at least three of the immediately preceding five years, reach age 21 and earn the minimum amount of compensation during the current year.
Bob worked for Employer X during his summer breaks from school in 2016, 2017 and 2018, but never more than 34 days in any year. In July 2019, Bob turned 21. In August 2019, Bob began working for Employer X on a full-time basis, earning $30,000 in 2019. Bob is an eligible employee in 2019 because he has met the minimum age requirement, has worked for Employer X in three of the five preceding years and has met the minimum compensation requirement for 2019.
Example 2: Employer Y writes its SEP plan to provide for immediate participation regardless of age, service or compensation. John is age 18 and began working part-time for Employer Y in 2019. John is an eligible employee for 2019.
Summary: Savings Incentive Match Plan for Employees allows employees and employers to contribute to traditional IRAs set up for employees.
It is ideally suited as a start-up retirement savings plan for small employers (100 or fewer employees) not currently sponsoring a retirement plan. With a SIMPLE plan, contributions are tax-deductible, and earnings within the account are tax-free until withdrawn. Employees are also 100% vested, which means they are able to take all funds, including employer contributions, with them if they leave.
You can establish a SIMPLE IRA plan if you meet BOTH of the following requirements:
You can establish a SIMPLE IRA plan only if you had 100 or fewer employees who received $5,000 or more in compensation from you for the preceding year.
Under this rule, you must take into account all employees who were employed at any time during the calendar year, regardless of whether they’re eligible to participate.
The SIMPLE IRA plan generally must be the only retirement plan to which you make contributions, or to which benefits accrue, for service in any year beginning with the year in which the SIMPLE IRA plan becomes effective.
A SIMPLE IRA allows:
Employers are generally required to match each employee’s salary reduction contributions, on a dollar-for-dollar basis, up to 3 percent of the employee’s compensation. You can deduct SIMPLE IRA contributions for the tax year within which the contributions were made.
If you are the sole proprietor of your business, you and your spouse may qualify for the Solo 401(k) option, which combines elements of the SEP and SIMPLE plans.
This option offers higher contribution amounts and possible tax deductions. However, there are precise qualifications that must be met in order to be eligible. Learn more about the Solo 401(k) and see if you qualify.
For more information about the difference between these plans, Equity Trust National Education Specialist John Bowens simplifies what you need to know in this whiteboard session:
What types of accounts does Equity Trust hold?
What is a self-directed IRA?
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