Simple Profit Sharing For You and Your Employees
For business owners who wish to provide additional incentives to employees by rewarding them with retirement contributions, a Simplified Employee Pension Plan (SEP-IRA) is a straightforward and affordable option. The SEP plan allows an employer to contribute to an employee’s SEP-IRA, providing additional incentive to attract new talent or motivate existing employees. If you are a business owner without any W-2 employees, see our blog on the Solo 401(k) plan. The SEP plan is easy to set up and operate, has low administrative costs, flexible annual contributions and no tax filing requirements.
If the SEP plan is going to be your company’s only form of retirement plan, it can be established by employers through a form 5305-SEP. The plan allows the employer to define contributions as a percent of salary, and change that percent each year as they desire. As long as each eligible employee receives the same proportional contribution relative to their salary, the percent can change as the business grows or shrinks. Total annual contributions can be up to 25% of an employee’s salary or $54,000 as of 2017. The contributions made by the employer also do not limit contributions that an employee can make to their personal Roth or Traditional IRA. The contributions made are also deductible from the business’s federal taxable income, and expenses incurred during the setup of the plan may also allow for a tax credit.
Along with setting up a SEP-IRA for your employees, you can also create one for yourself. The same contribution rules and limits apply. The potential downside is that contributions to yourself have to be based on the same percent of salary as your employees. So, if you want to put away 20% of your salary, you need to contribute 20% of salary for each employee as well. However, from an employee’s perspective, aligning your incentives with theirs can be very motivating and endearing. It puts the workplace on an even playing field and creates a team-oriented atmosphere.
SEP-IRAs are maintained by the financial institution of the employer’s choosing, and regular due diligence should be conducted in order to pick the proper advisor to hold the funds. SEP plans are low cost because they are self directed plans. The individual is able to pick his/her own investments, which means that they are not limited to a small menu of items. The investments can, in some cases, expand beyond stocks and bonds to include options, real estate and commodities.
Contributions can not be made to employees or yourself in a fiscal year in which the business operates at a net earnings loss. Furthermore, payments should not be made in excess of the maximum allowable limit, as the result is an excise tax on both the employee and the employer. Normal contributions are not subject to an employee’s regular income taxes, but are subject to social security, Medicare and federal unemployment taxes.
Needless to say, it is not too complicated to stay within the boundaries of the tax code with this simple and helpful product. For employers who want to give back and reward their employees with an easy to understand profit sharing plan, the SEP-IRA is an extremely useful tool.