With over 60 million people employed by small businesses, and a secure retirement growing seemingly out of reach for many of them, employers are under tremendous pressure to provide their employees with an employer-sponsored retirement plan.
The primary obstacle for many small businesses to establishing a plan has been the time and cost of implementation and administration.
The solution for may be a Simplified Employee Pension plan (SEP) that was created to provide small businesses with a simplified way to establish a retirement plan for their employees.
How a SEP Works
A SEP is a form of IRA account. All employees 21 and older, earning at least $550 per year and who have worked three out of the previous five years are eligible to participate.
The employer can, at its discretion, make an annual, tax deductible contribution of up to 25% of covered compensation or $54,000, whichever is less. (These are the 2017 limits and will be indexed for inflation in subsequent years.)
Self-employed individuals may also establish SEPs and make contributions based on net earnings, but there are slightly different rules around contribution limits and calculations.
Although you can do the paperwork yourself, the easiest way to establish one is to work with a company that handles the paperwork and provides the investment vehicles for the plan.
Most discount brokerage firms have easy to use plan packages, with a wide array of investment options and low or non-existent fees. This also gives your employees access to investment advice.
Is a SEP Right for Your Business?
The biggest advantage of a SEP is that there is virtually no administration and minimal reporting for employers. Another advantage is that, although all contributions are to be made by the employer, they are not mandatory, so the employer can manage its contributions around the company’s profitability.
Each employee is able to direct his or her own investments which can consist of stock and bond mutual funds or cash accounts such as a money market fund, which relieves the employer of that responsibility.
The employer’s contributions generally are not currently taxable to the employee and are tax deductible for the business. Taxes on the contributions and earnings in the investment accounts are deferred until withdrawal, in much the same way as a regular IRA.
On the downside, employers must contribute on behalf of seasonal and part-time employees if they meet the eligibility requirements.
Employee contributions are 100% vested immediately and employees are allowed to withdraw their funds at any time, although they will be subject to taxes and, possibly, a penalty fee.
Because employees are not making any contributions from their earnings, there may be a sense of no “skin in the game” which could make the benefit less visible to employees as part of their total compensation.
The SEP is definitely worth exploring for small businesses that want to offer their employees a valuable benefit in a simple and affordable way, but do not want to be locked into a plan requiring annual contributions and with high administrative costs. It can be particularly beneficial for small firms with limited numbers of employees, or in which many, or all, of the employees are owners of the business.
A growing business needs to be able to attract and retain quality employees, and people who are conscious of their financial future will look for a retirement plan as one of their criteria when choosing a company. A SEP may be a flexible way to provide that and improve your recruitment of talented staff.