- Since 1974, Congress has rolled out a number of different variations on the IRA theme. Roth IRAs do not offer tax deductions on contributions but offer tax-free growth and tax-free withdrawals. SIMPLE IRAs provide a simplified means for small businesses to set up defined contribution plans. Workplace 401k plans allow workers to defer income for retirement on a pre-tax basis. A Simplified Employee Pension Plan, or SEP, allows an employer to contribute to a retirement fund on behalf of employees.
- The SEP plan is an employer-sponsored defined benefit pension plan that allows employers to contribute to a retirement fund on behalf of their employees. The contributions are tax-deductible to the company, and the company can contribute to plans set up on behalf of its owners. S-corporations, C-corporations, limited liability corporations, partnerships and sole proprietorships all qualify to set up a SEP.
- As of 2010, a SEP had a maximum contribution limit of $49,000 or 25 percent of income, whichever is less, in most cases. However, specific rules apply depending on whether the business owner receives a W-2 from the company or just takes money out as personal income without a W-2. In this instance, contributions are generally limited to 20 percent of income.
- Contributions to SEPs are generally 100 percent tax-deductible to the business and generally not taxable to the employee in the current year. Once credited, the accounts grow tax deferred. As long as the money stays in the account, there are no capital gains taxes due on any sales, nor is there income tax due on dividends or interest income. When funds are withdrawn in retirement, the account owner pays income taxes on the amount withdrawn. A 10 percent penalty may apply to early withdrawals prior to age 59 1/2. You must begin taking withdrawals starting in the year in which you reach the age of 70 1/2, and pay income taxes on those withdrawals. If you fail to take your required minimum distribution, the Internal Revenue Service (IRS) levies a penalty of 50 percent of the distribution you were supposed to take.
- Congress has authorized a tax credit to encourage business owners to save for their own retirements and to assist their employees with doing the same. The tax credit amounts to 50 percent of the startup costs for the first three years of the plan. To qualify, you must have had 100 or fewer employees who made more than $5,000 each last year. At least one participant may not be a highly compensated employee. You can claim the credit by filing an IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs.
- In addition to the Simplified Employee Pension Plan, employers may establish a SIMPLE IRA plan, contribute to a traditional IRA or Roth IRA for themselves, or establish a 401k plan. Each plan has unique tax and administration characteristics which are spelled out in IRS Publication 560, Retirement Plans for Small Business, and IRS Publication 590, Individual Retirement Arrangements. You can also set up retirement savings using cash value life insurance, which generally grows tax free and has fewer restrictions on when you can access the funds. Anyone may also purchase annuities, which provide tax deferral, though do not provide tax deductions on current purchases unless the annuities are purchased within tax deferred retirement accounts. However, some established businesses with steady cash flows may be appropriate matches for Section 412e insured pension plans.
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