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How do SEPs and SIMPLEs stack up?

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in Small Business Tax,Small Business Tax Deduction Strategies

For years, retirement plan options for small business owners were limited. But not now.

Strategy: Compare the Simplified Employee Pensions (SEP) with the Savings Incentive Match Plan for Employees (SIMPLE). Here’s a review of the key aspects of the two plans.   

The skinny on SEPs

Eligibility: With a SEP, contributions must be made for all employees age 21 or older who have worked for your company full time three out of the previous five years (absent any other union agreement). Part-time employees, or those who worked for the company only part of the year, must be covered under the plan if they earn more than $550 in 2013.

Contribution limits: For 2013, the maximum deductible contribution limit per participant is the lesser of (a) 25% of compensation or (b) $51,000. The maximum amount of compensation that may be taken into account for this purpose in 2013 is $255,000. But contributions are discretionary, so you can boost them in good years or skimp in bad years, as long as you contribute the same percentage of compensation for all participants.

Vesting rules: Contributions are vested immediately. Conversely, other qualified plans may use “cliff vesting” or gradual vesting over a period of years.

Distributions: As with other qualified plans, you must begin taking “required minimum distributions” (RMDs) from a SEP after you turn age 70½. (An exception applies for nonbusiness owners who keep working.) If you make withdrawals prior to age 59½, you’re subject to a 10% penalty tax, on top of regular income tax, unless you meet one of the tax law exceptions.

Due date: Generally, employers have until the end of the year to set up a qualified retirement plan. But you can still establish a SEP and fund it after the end of the tax year if you submit the paperwork by the tax return due date (plus extensions).

The skinny on SIMPLEs

Eligibility: An employer can set up a SIMPLE only if it has 100 or fewer employees. Any employee who was paid at least $5,000 for any two previous years at your company (and expects to receive at least that amount in the current year) is eligible to participate.  

Contribution limits: For 2013, participating employees may elect to contribute up to $12,000 to the plan. The limit bumps up to $14,500 if you’re age 50 or older. Generally, employers must provide matching elective contributions of up to 3% of compensation (but no less than 1% in no more than two out of five years) or nonelective contributions of 2% of each eligible employee’s compensation (based on the maximum compensation limit). The matching contributions are deductible.

Vesting rules: As with SEPs, contributions to SIMPLEs vest immediately.

Distributions: The RMD rules also apply to SIMPLEs. But note that the usual 10% penalty tax for pre-age 59½ distributions increases to 25% in the first two years of participation.

Due date: A SIMPLE can be set up at any time during the current year before Oct. 1. Unlike a SEP, however, the plan cannot be established after the close of the tax year.

Tip: There’s no “right” or “wrong” choice. Figure out what’s best for you.

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