Starting a Retirement Plan with SEP-IRA

With a Social Security system that is unlikely to keep up with the growing number of retired people expected in the coming years, planning for retirement has become a necessity. Nearly 1 in 5 small businesses now offer a retirement plan, according to a recent study. Is it time for your company to count itself among those offering this benefit?

A fear I commonly hear cited by small business owners about starting a retirement plan is that it could become a financial runaway train. Owners are concerned that sponsoring a plan will require ongoing financial commitments that they may not be able to keep up with during uncertain economic times.

While there are plans that do require employers to contribute to plans year in and out, not all do. One of the easiest ways to dip your company's toes into the retirement waters is by starting a Simplified Employee Pension IRA, or SEP-IRA plan.

Essentially, a SEP-IRA acts as an employer-sponsored IRA, with much higher contribution limits. Contributions can be as much as 15% of an employee's total compensation, with a maximum contribution of $25,500 for 2001. If you're self-employed, the percentage contribution is 13.04% to the same dollar limit. In contrast, personal IRAs have a $2,000 yearly maximum contribution.

One of the key features of this plan is the ability for the employer to determine how much will be contributed yearly. This gives you the flexibility of determining contributions according to how well the company is doing. Keep in mind that payouts do need to be evenly distributed, though, with all employees receiving the same percentage contribution in the years that you do make contributions.

The SEP-IRA is also probably the easiest small business retirement plans to administer. The company simply opens an IRA for each participating staffer. There are no annual reports that need to be filed with the IRS, as is required by more complex plans like a 401(k) plan. An annual statement to each employee notifying of the total contribution made is the primary reporting requirement.

Drawbacks to the plan include the fact that employees are not allowed to contribute. In addition, all qualifying employees must be covered by this plan. Qualifying employees include those who are at least 21 years old, have been employed for three or more of the last 5 years and earned at least $400 each year. Under these conditions, this can mean that part-time employees would need to be covered.

In addition, vesting is immediate. That means that employees are immediately entitled to whatever money is in their accounts. More complex plans have vesting periods where the benefits accrue and are earned by the employee only after a certain period of time. Vesting can encourage employee retention.

Thinking about the future can be difficult when there is so much to handle in the present. Perhaps not surprisingly, 52% of small businesses surveyed in another study are not familiar with SEP-IRAs. Now that you are, you can help make the golden years truly golden.