02/20/2001

Retirement for the Self-Employed

It is income tax time and, if you are like many self-employed people, you are looking for a way to reduce income taxes. One of the best ways to reduce income taxes and to plan for your future is to establish a SEP. SEP stands for Simplified Employee Pension Plan and it is, in my opinion, one of the most advantageous retirement plans for the self-employed. It also works very nicely for a small business owner who wants to fund retirement for employees. Most importantly, there is still time to establish and fund a plan in order to save on your 2000 income taxes.

The first thing to know is the plan lives up to its name -- it's simple.

The SEP is simple, and has remained largely unaffected by the changes in eligibility, required contribution, withdrawal and tax requirements that have gone with other retirement vehicles. As a result, the SEP is a great first-line retirement plan option for many self-employed and small business owners because of the attractive features and benefits it has always offered and that are still part of the plan.

The advantages are many and varied.

Under SEP rules, an employer can contribute up to 15% of a plan participant's annual salary, not to exceed $30,000, into a SEP "IRA" account each year. For an employee, and for a self-employed individual the maximum allocation to a SEP is $25,500.

This basic guideline, though, is accompanied by numerous advantages to both employers and employees:

• Wide applicability: Almost all self-employed individuals and small businesses can establish an SEP for themselves and their employees. Whether a sole proprietorship, a "C" or "S" corporation, a joint venture or another of the corporate designations -- whether you're on your own or with dozens of employees -- the SEP can apply.

• Contribution flexibility: Employers can contribute up to 15% of salary. If the business has an off year, the employer may contribute less, or even nothing at all. (In this way, it works just like a profit sharing plan.) However, all employees must be treated equally on a percentage basis. If, as the employer, you want to contribute 10% of your salary to the SEP plan, all eligible employees must also receive contributions at the 10% level of their salaries. The SEP is a flexible vehicle for employees, too, as they may add their own annual contributions of $2,000 (or 100% of their earned income, if it's less than $2,000) to the employer-sponsored plan. Such a move does count, however, as the employee's annual IRA contribution.

• Low-cost, easy set-up, maintenance and fiduciary responsibilities: Generally, IRA setup and (negligible) annual maintenance fees are the only costs associated with establishing an SEP. And because there are no annual company-level SEP reporting requirements to the IRS (no 5500s) or Department of Labor, the employer cuts down on administrative and accounting costs. What's more, SEP participants own their own accounts (though there might be a vesting schedule) and select their own investments. Because employees enjoy control of their accounts, they are obligated to monitor investment performance, and the fiduciary responsibility of the employer is reduced.

• Tax advantages: The SEP perhaps best performs as a viable retirement plan option for the notable tax advantages it delivers all around:
  1. Employer SEP contributions are tax-deductible for the company and tax-deferred for the employee. Compared to simply surrendering profits to Uncle Sam in taxes, the employer, through an SEP, has the opportunity to both build his or her own retirement, and to attract and retain good employees by building theirs. And with SEP contributions not due until April 15 for the previous tax year, companies gain an additional business management option.
  2. All earnings are tax-deferred until withdrawn. Here the tremendous power of compounding comes into play. Even assuming modest rates of return on annual contributions, SEP compounding can, after only a few years, deliver assets well above what would have accumulated had the money been paid in salary with taxes taken out along the way. With these funds withdrawn and taxed at retirement, when many persons are in a lower tax bracket, SEP participants gain all the more.

Please send questions or comments to dcoffin46333@wradvisors.com.