A couple of clients have been asking for the distinctions of possible retirement savings plans, I hope this basic listing helps.
SEP
A SEP is a Simplified Employee Pension plan. Because this is a simplified plan, the administrative costs should be lower than for other, more complex plans. Under a SEP, employers make contributions to traditional Individual Retirement Arrangements (IRAs) set up for employees (including self –employed individuals), subject to certain limits.
To establish a SEP, you:
- Can be a business of any size, even self-employed.
- Must adopt a SEP plan document.
- Generally cannot have any other retirement plan.
Advantages:
- Easy to set up and operate – usually just a phone call to a financial institution gets things started.
- Administrative costs are low.
- Plan can have flexible annual contribution obligations – a good plan if cash flow is an issue.
Under a SEP, you, the employer, make contributions to traditional IRAs (SEP-IRAs) set up for each of your eligible employees. A SEP is funded solely by employer contributions. Each employee is always 100% vested in (or, has ownership of) all money in his or her SEP-IRA.
Simple
A SIMPLE IRA plan is a Savings Incentive Match PLan for Employees. Because this is a simplified plan, the administrative costs should be lower than for other, more complex plans. Under a SIMPLE IRA plan, employees and employers make contributions to traditional Individual Retirement Arrangements (IRAs) set up for employees (including self-employed individuals), subject to certain limits. It is ideally suited as a start-up retirement savings plan for small employers who do not currently sponsor a retirement plan.
To establish a SIMPLE IRA plan, you:
- Have a business with, generally, 100 or fewer employees.
- Need to complete just a form or two.
- Cannot have any other retirement plan.
Advantages:
- Easy to set up and run – usually just a phone call to a financial institution gets things started.
- Administrative costs are low.
- Employees can contribute, on a tax-deferred basis, through convenient payroll deductions.
- You can choose either to match the employee contributions of those who decide to participate or to contribute a fixed percentage of all eligible employees’ pay.
401K
A 401(k) plan is a qualified (i.e., meets the standards set forth in the Internal Revenue Code (IRC) for tax-favored status) profit-sharing, stock bonus, pre-ERISA money purchase pension, or a rural cooperative plan under which an employee can elect to have the employer contribute a portion of the employee’s cash wages to the plan on a pre-tax basis. These deferred wages (elective deferrals) are not subject to federal income tax withholding at the time of deferral, and they are not reflected as taxable income on the employee’s Form 1040, U.S. Individual Income Tax Return.
The employer reports elective deferrals on the participant’s Form W-2, Wage and Tax Statement. Although these amounts are not treated as current income for federal income tax purposes, they are included as wages subject to social security (FICA), Medicare, and federal unemployment taxes (FUTA). Refer to Publication 525, Taxable and Nontaxable Income, for more information about elective deferrals. Refer to the Form W-2 Instructions, for more information on how amounts should be reported.
401(k) plans are permitted to allow employees to designate some or all of their elective deferrals as “Roth elective deferrals” that are generally subject to taxation under the rules applicable to Roth IRAs. The information contained in this guide does not pertain to Roth 401(k)s unless specifically stated.
Two of the tax advantages of sponsoring a 401(k) plan are:
- Employer contributions are deductible on the employer’s federal income tax return to the extent that the contributions do not exceed the limitations described in section 404 of the Internal Revenue Code. Refer to Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans), for more information about deduction limitations.
- Elective deferrals and investment gains are not currently taxed and enjoy tax deferral until distribution.
Traditional IRA
A traditional IRA is a personal savings plan that gives you tax advantages for setting aside money for retirement.
- Contributions you make to a traditional IRA may be fully or partially deductible, depending on your circumstances and
- Generally, amounts in your traditional IRA (including earnings and gains) are not taxed until distributed.
Roth IRA
A Roth IRA is an individual retirement arrangement that, except as explained below, is subject to the rules that apply to a traditional IRA. It can be either an account or an annuity.
To be a Roth IRA, the account or annuity must be designated as a Roth IRA when it is set up. A deemed IRA can be a Roth IRA, but neither a SEP-IRA nor SIMPLE IRA can be designated as a Roth IRA. Unlike a traditional IRA, you cannot deduct contributions to a Roth IRA. But, if you satisfy the requirements, qualified distributions (defined in Publication 590) are tax free. Contributions can be made to your Roth IRA after you reach age 70 1/2 and you can leave amounts in your Roth IRA as long as you live.