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Retirement planning just became simpler for small business owners and their employees.
Starting this year, companies with 100 or fewer workers are able to sponsor a Savings Incentive Match Plan for Employees, or SIMPLE plan.
The SIMPLE plan has been criticized, including in this column (Dec. 23), as being a savings vehicle that is less attractive than the now-defunct Salary Reduction Simplified Employee Pension plan or SARSEP . However, I contend that a SIMPLE plan can be of significant value to a small business.
The new pension plan is part of sweeping legislation passed in August 1996 that can substantially alter the retirement landscape.
The Small Business Job Protection Act of 1996 and the Health Insurance Portability and Accountability Act is good news for many Americans, offering increased IRA contributions for married couples filing jointly, expanded 401(k) options, and extended tax deferrals for those choosing to work into their senior years.
The 1996 retirement laws also offer incentives for small companies to set up tax-deferred retirement plans, such as SIMPLE, and should allow more Americans to invest in their retirement.
How does a SIMPLE Plan work? It allows employees to make pre-tax salary deferrals into an IRA or 401(k) investment vehicle.
This is a significant development for smaller companies. In the past, employers with more than 25 employees were unable to offer a simplified salary deferral plan to their workers.
401(k) plans were often too costly to establish and maintain, and SARSEPs (Salary Reduction Simplified Employee Pension Plans) were restricted to companies with 25 or fewer employees. True to its name, the SIMPLE plan makes establishing and administering a retirement plan easier and more enticing to small business owners than in the past. Most administrative duties and costs associated with qualified retirement plans have been removed from the employer.
In addition, many of the complex rules and reporting requirements associated with qualified plans have been eliminated.
Small business owners may find the SIMPLE plan a flexible and feasible way to meet the challenge of providing for retirement.
To participate in a SIMPLE IRA plan, employees must have earned at least $5,000 in the past two years and expect to earn $5,000 in the current year. Workers can contribute up to $6,000 of income annually. Because there is no limitation on the percentage of earnings that can be deferred, the plan offers many employees an opportunity to defer a greater portion of their compensation.
For example, an employee earning $6,000 could defer 100 percent of his or her compensation.
Companies sponsoring a SIMPLE plan must generally match employee contributions dollar-for-dollar up to 3 percent of the worker's compensation, although alternative company contributions can be made.
Both participant and employer matching contributions are fully vested immediately. As with most retirement plans, SIMPLE contributions are deductible from taxable income and grow tax-deferred until withdrawn. Early withdrawals are subject to penalty.
If an employee withdraws money during the first two years he or she belongs to the plan, and if an early distribution penalty applies, he or she will be subject to a special 25 percent penalty. After the two-year period, a 10 percent early distribution penalty associated with an IRA applies. In fact, many IRA rules, such as distributions, rollovers, transfers, and reporting, will be the same for SIMPLE.
These plans will be fully self-directed, which means the investor controls how the money is invested. For example, an investor may choose from any number of investment vehicles including CDs, stocks, bonds or mutual funds.
Of course, investment decisions should be based on several factors, including an employee's age, current economic environment, income sources and risk tolerance.
Employers with 100 or fewer employees who want 401(k) plan features, such as loans, together with the ease and reduced administration costs of a SIMPLE plan, can use SIMPLE as part of a qualified 401(k) plan.
If an employer applies the eligibility and general contribution rules for SIMPLE, the 401(k) plan will not be subject to the top-heavy or special 401(k) discrimination tests. The employer will also benefit by having reduced reporting requirements and lower administration costs. The investments in SIMPLE 401(k) plans can be the same as other qualified plans.
What about SARSEPs?
After Dec. 31, 1996, SARSEPs, pension plans designed for companies with 25 or fewer employees, may no longer be established. However, SARSEPs established prior to 1997 may continue to be funded and maintained.
Given estimates that it will take the equivalent of 70 percent of pre-retirement income to maintain one's current standard of living, it's no surprise that planning for retirement is a top investment concern of many Americans.
Keep in mind that this article addresses just some of the changes set forth in the legislation and that Prudential Securities is not a legal or tax advisor.
Consulting a legal, tax and financial advisor can help small business owners and their employees make sense of the new retirement laws and decide whether a SIMPLE plan is the right plan for them.
1. Contact a tax advisor to find out if your business qualifies for a SIMPLE plan. Things to discuss: number of employees (must have 25 to 100 employees), administration costs, contribution amount.
2. Review your existing retirement plan to compare it with the SIMPLE plan. Points for comparison are: administration costs, contribution amount, the simplicity of this program vs. 401(k) program. (Essentially, SIMPLE is a simplified 401(k) program.)
3. Consult an investment advisor to determine the easiest way to set up and implement a SIMPLE plan. This can be done on your own, but as with any investment changes, it is always a good idea to seek professional advice from a tax attorney, investment advisor, accountant, etc.
David Bender is a financial advisor and senior vice president of investments for the Bender Investment Group at Prudential Securities' Encino office.
Small Business is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact Dan Rabinovitch at (213) 743-2344 with feedback and topic suggestions.
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