In this summary, "you" means the employer (sole proprietor or corporation), and "plan" means your retirement plan.
Many financial institutions will help you set up a retirement plan.
At the end of this summary you will find links to the IRS website for more detailed information.
First, before describing the various types of retirement plans, lets start with some general information about retirement.
Contributions to employees’ retirement funds can be made from two sources, the employee and the employer. There are three types of contributions.
(1) An employee contribution, which must be made from the employee’s own payroll. This is called an “elective” salary deferral because the employee elects whether or not to make it.
(2) An employer contribution to employees’ accounts. This is known as a “non-elective” contribution because an employee cannot elect to make this contribution. Only the employer can.
(3) An employer “match” contribution, which matches, to some degree, the employee’s elective contribution.
The type of retirement plan determines which types of contributions can be made. Some plans only include one type of contribution, and some include all three, or a combination. These contributions are also subject to minimum and maximum amounts, which is also dependent on the type of plan.
Employer contributions to employees, both the “non-elective” and the “match,” are not subject to FICA and FUTA taxes. Employee’s elective contributions made from their salaries are.
Personal federal and state income taxes on all three types of contributions are deferred until distributions are made.
All employer contributions and the expenses incurred by an employer to administer a retirement plan are tax deductible to the employer.
A summary of the three types of pension plans listed here
· Savings Incentive Match Plan for Employees (SIMPLE plan)
· Qualified Plans (401(k) plans, 403(b) plans, also known as Keogh Plans)
SEP Plans established after 1996 cannot provide for employee contributions as a deferral from their salaries. If you are interested in setting up a retirement plan that includes an elective salary deferral, see SIMPLE PLANS later.
You establish SEP-IRA accounts for each eligible employee and for yourself at a financial institution. You make tax deferred employer contributions to these SEP-IRA accounts. Each employee owns and directs their individual SEP-IRA account. These accounts are subject to deferred federal and state income taxes, but not subject to FICA or FUTA taxes.
1. The plan must be in writing. You may be able to use Form 5305-SEP to up the plan. .
2. Employer notification of the SEP must be given to the eligible employees. You can give each eligible employee a copy of Form 5305-SEP, its instructions, and the other information listed in the form to satisfy this requirement.
3. A SEP-IRA account must be set up for each eligible employee.
Note: Many financial institutions will help you set up a SEP.
Eligible Employees
1. Must be age 21
2. Has worked for you in at least 3 of the last 5 years.
3. Has received at least a minimum amount of compensation from you ($450 in 2000).
Note: You can use less restrictive participation requirements than these, but not more restrictive.
Ø Contributions are discretionary. You do not have to make contributions every year.
Ø They must be based on a written contribution formula and must not discriminate in favor of the highly compensated employees.
Ø Contributions you make to a common law employee cannot exceed the lesser of 15% of the employee’s compensation or $30,000. Compensation includes wages, bonuses, and fringe benefit for services performed.
Ø You cannot consider the amount of an employee‘s compensation over $170,000 when figuring your compensation limit to an employee. Therefore, $22,500 is the maximum compensation for an eligible employee whose compensation is $170,000 or more.
Ø If you are self employed special rules apply when figuring your maximum deductible contribution. Your gross income to base the 15% maximum allowable contribution amount is the net earnings from your self-employment Allowable business deductions include contributions to the employees’ SEP-IRA accounts, the deduction allowed for one-half of your self-employment tax, and the contribution to your own SEP-IRA account. Because your contributions to your own SEP-IRA and your net earnings depend on one another, the IRS provides a particular worksheet (visit the IRS website on the link below) to calculate your net earnings.
Under a SIMPLE Plan, employees can choose to make elective salary reduction contributions to provide retirement income. In addition, you will contribute either matching or non-elective contributions.
Simple plans can only be maintained on a calendar year basis. A SIMPLE plan is set up using SIMPLE IRAs (SIMPLE IRA plan) or as part of a 401(k) plan (SIMPLE 401(k) plan).
1. Employee elective contributions are limited to $6,000 per calendar year for the year 2000.
2. Employer matching contributions are required to be made by you, the employer, on a dollar for dollar basis, up to 3%, but not less than 1%, of the employee’s compensation. You cannot choose a percentage less than 3% for more than 2 years of a 5 year period that ends with and includes the year for which the choice is made. This requirement does not apply if you make non-elective contributions.
3. Employer non-elective contributions – Instead of matching contributions, you can choose to make non-elective contributions of 2% of employees’ compensation for each eligible employee who has at least $5,000 of compensation for the year. If you make this choice, you must notify the employees within a reasonable period of time before the 60-day election period. Only $170,000 of the employee’s compensation is subject to the non-elective contribution percentage.
Time limits for contributing funds
1. Employee elective contributions must be deposited to their SIMPLE IRA accounts within 30 days after the end of the month during which the salary reductions were made.
2. Employer match contributions and employer non-elective contributions must be made by the due date (including extensions) for filing your federal income tax return for the year.
Qualified retirement
plans
Qualified
retirement plans set up by self-employed individuals are sometimes called Keogh
or H.R. 10 plans. A sole proprietor or a partnership can set up a qualified
plan. A common-law employee or a partner cannot set up a qualified plan.
Qualified
plans set up by employers that are corporations are usually referred to as
Profit Sharing plans and 401(k) plans.
All
the rules discussed here apply to corporations except where specifically
limited to the self-employed.
The
plan must be for the exclusive benefit of employees or their beneficiaries. A
qualified plan can include coverage for a self-employed individual. A
self-employed individual is treated as both an employer and an employee.
There are two basic kinds of qualified
plans:
1.
Defined contribution plan – This plan provides benefits
based on the amount contributed to a participant’s account.
2.
Defined benefit plan – Contributions to a defined benefit
plan are based on what is needed to provide definitely determinable benefits to
plan participants. Actuarial assumptions and computations are required to
figure these contributions. Generally, you will need continuing professional
help to have a defined benefit plan.
Different rules apply to each kind of
plan. You can have more than one qualified plan, but your contributions to all
the plans must not total more than the overall limits. The remainder of this
summary pertains to defined contribution plans.
In a Qualified plan,
Ø Employer
non-elective contributions are made through a Profit-sharing
plan. Although it is called a profit-sharing plan, there is no correlation
with the profits of the employer. A corporation can have a taxable loss and
still make a non-elective contribution. Your contributions are discretionary,
i.e., you do not have to make contributions every year. Also:
·
The plan must provide a definite formula for allocating the
contribution among the participants.
·
The employer contributions can be set to a vesting
schedule, whereby the employee vests ownership in the employer contributions
over the time.
Ø
Employee elective salary deferral
contributions are made through a 401(k) plan. An employer
match can be included in this plan.
You must adopt a written plan and
communicate the plan to your employees. The plan can be an IRS-approved master
or prototype plan offered by a sponsoring organization. Or it can be an
individually designed plan.
Most qualified plans follow a standard
form of plan (a master or prototype plan) approved by the IRS. Master and
prototype plans are plans made available by plan providers for adoption by
employers
Plan providers.
The following organizations generally can provide IRS-approved master or
prototype plans.
Although advance IRS approval is not
required, you can apply for approval by paying a fee and requesting a
determination letter. You may need professional help for this.
In setting up a qualified plan, you
arrange how the plan's funds will be used to build its assets. You can establish a trust or custodial
account to invest the funds by a legal instrument (written
document). You may need professional help to do this.
You can set up a custodial account
with a bank, savings and loan association, credit union, or other person who
can act as the plan trustee.
An employee is one that meets both the
following requirements.
1.
Has reached age 21
2. Has at least 1 year of service. You can waive this requirement.
A defined contribution plan's annual contributions and other
additions (excluding earnings) to the account of a participant cannot exceed
the lesser of the following amounts for 2000
·
25% of the compensation actually paid to the participant.
· $30,000.
The maximum compensation that can be taken into account for this limit is $170,000.
In general, a qualified plan can
include a 401(k) plan only if the qualified plan is a profit sharing plan.
Plans typically limit the amount an
employee can contribute to 15% of the employee’s compensation, as that is the
limit that an employer can deduct for the employer’s income taxes. In addition,
elective deferrals are limited to an annual amount of $10,500 (for 2000).
SIMPLE 401(k) plan.
If you had 100 or fewer employees who earned $5,000 or more in compensation
during the preceding year, you may be able to set up a SIMPLE 401(k) plan. A
SIMPLE 401(k) plan is not subject to nondiscrimination and top-heavy plan
requirements.
Nondiscrimination Requirements.
Under the plan, contributions or benefits to be provided must not discriminate
in favor of highly compensated employees.
Top-heavy requirements.
A top-heavy plan is one that mainly favors partners, sole proprietors, and
other key employees.
A plan is top heavy for any plan year
for which the total value of accrued benefits or account balances of key
employees is more than 60% of the total value of accrued benefits or account
balances of all employees. Additional requirements apply to a top-heavy plan
primarily to provide minimum benefits or contributions for non-key employees
covered by the plan.
Most qualified plans, whether or not
top heavy, must contain provisions that meet the top-heavy requirements and
will take effect in plan years in which the plans are top heavy.
For more detailed information on retirement plans for employers, visit the IRS website: http://www.irs.gov/bus_info/ep/retirement.html