Welcome to lesson five.
This lesson is about doing something great for yourself and your employees, setting up and maintaining a retirement plan.
In this lesson we'll discuss reasons for adopting a retirement plan now.
You'll learn about two types of retirement plans, SEPs and SIMPLE IRA plans that are tailor made for business owners like you.
And you'll learn where to go for retirement plan information provided by the IRS.
Taking steps to set up a retirement plan when your business is young and so much effort is required to make it a success may not be something you've thought about very much, but you should.
The years will fly by and you may well want to, or have to think about retiring.
Maintaining the same lifestyle during retirement requires an income stream of between 60 to 80% or even more of the income needed while you're working.
The lower your current income, the higher percentage of it you'll need in retirement.
Well I don't know if I even want to retire, I can't imagine not working and even if I do decide to retire, I'll sell the business and use the proceeds to pay for my retirement.
And there's always social security.
Sometimes, when or even if we retire isn't as much a choice as a necessity.
Health or family issues may mean that you need to stop or cut back on working before you'd like, but your need for income will continue.
Entrepreneurs tend to be people who are hardworking and high energy.
They're self-motivated, risk taking, confident, focused.
They may be more inclined than most people to put all their eggs in one basket, and that basket is their business.
These are the traits that make businesses successful, but it's also smart to diversify investments in order to minimize risks in the future.
For instance, you may need to sell your business at a bad time and it may not bring the amount you and your family need to live comfortably.
A retirement savings plan separate from the investment in your business is the smart thing to do and it will help you attract and keep the kinds of employees a successful business needs.
How can I afford a retirement plan, I'm putting every hour and every dollar I have into the business.
A retirement plan may be a good idea, but come on!
Okay, but you're just not convinced that a retirement savings plan is that important right now.
We've heard some reasons people may be using for not getting going on a savings plan.
Maybe you'll recognize one or more of these.
It's one thing after another with the kids.
If it's not school clothes, it's dental bills.
There just hasn't been money for something that's off in the future when the now is so now!
I've got to stay focused on the here and now.
Getting my business off the ground and keeping it going has taken every dollar and every hour that I have.
A retirement plan is one of those nice to have things that I'll look at later.
Retirement isn't what I'm thinking about now.
I've got student loans and car payments to worry about.
I've got a retirement plan on the job, but I don't know how it really works or how to choose investments.
I sure can't afford to lose money I might save for my old age.
I think my expenses will be lower once I'm retired.
Social security and Medicare will be a big help and I plan to work part time so I ought to be okay.
Setting up a retirement plan would take a lot of effort and money and I don't know if I can afford to fund it every year.
What happens if my business goes through a rough patch?
Who would I talk to about this?
Who can I really trust to give me good advice about investments?
I'd have to tell them I haven't really started saving yet and that would be embarrassing.
You never know, I may win the lottery, or maybe I'll inherit money or they may find a diamond mine in my backyard.
You may think that a retirement plan is too expensive, too complex, and takes too much of your time and effort.
But that doesn't have to be true.
There are retirement plans for small businesses that require little effort to set up and run.
They give you and your employees a way to put away the kind of money you'll need for retirement.
Each employee takes responsibility in making investment decisions for their own IRA.
You don't need to worry about how to invest any but your own account and the plan can be set up so that you don't have to fund the plan when your business can't afford it.
There's even a tax credit many businesses can claim that helps pay the start up and operating costs for new retirement plans.
I'll tell you more about this later in this lesson.
Your financial institution can help you get started.
Convinced?
The next step is picking the retirement plan that makes the most sense for you and your business.
Spend a little time looking at choosing a retirement solution for your small business.
It will give you a quick course in all the types of retirement plans that are available.
There's at least one for every business.
We'll be focusing on SEP and SIMPLE IRA plans in this lesson.
They're easy and inexpensive for small business owners to set up and operate.
They provide an opportunity for you and your employees to put away significant money for retirement.
Spending a few minutes to fill out a short form can get you started.
In this lesson we'll be looking at two retirement plans that are easy to operate and have significant tax advantages, SEP and SIMPLE IRA plans both hold participants' retirement assets in traditional IRAs.
SEPs are funded with employer contributions.
SIMPLE IRA plans provide for both employer and employee contributions.
Let's get started by looking at SIMPLE IRA plans.
Now that you've decided to go with the SIMPLE IRA plan, let's go ahead and set up IRAs for each of your employees.
Did you bring that information that we need for each of your employees?
Okay.
Great.
Now you told me that you like the variety of our investment options that you'll have with us, but let me just point out one thing.
Our account fees are some of the lowest in the industry which means that your employee accounts will grow faster.
Of course your employees can, if they want to, move their accounts to another firm, but we hope they'll want to stay with us when they see the kind of service we have to offer.
Now since you're going to be making all of your contributions to your employee IRAs with us, we can set up the plan using the IRS Form 5305 SIMPLE.
You will fill in these sections here, here, and here.
They say who is eligible to participate in the plan, what the employee must do to receive an allocation, and which formula will be used for you to make your employer contributions.
Then you will sign and date it here.
Now you can make copies of all the sections of the form and the instructions and hand them out to your employees.
Then you will have met the requirements for the summary description of the plan and the information regarding transfers and withdrawals.
Now you'll need to notify your employees about how the plan operates and that they can make changes in their salary reduction agreement or make a new one, just before November the 2nd, that's 60 days prior to the beginning of the new plan year.
I'll explain all of that to you later when we get closer.
That's it?
Yeah, that's it.
Then you have a retirement plan.
Great.
Great.
If you want to have your employees choose their own financial institution for their simple IRA accounts, you can use IRS Form 5304- SIMPLE to establish the plan.
Then your SIMPLE IRA plan operates pretty much the same.
You've got a written agreement, you notified your employees and there are IRAs ready to receive contributions.
Let's talk for a minute about the employer contribution choices you'll make with your SIMPLE IRA plan.
You can use one method one year and the other next year.
You may either make a contribution of 2% of compensation for each eligible employee or match employees' salary contributions on a dollar for dollar basis up to 3% of compensation, but only for those employees making salary reduction contributions.
Salary reduction contributions are sometimes called elective deferrals.
That's where the employee asks the employer before the compensation is payable, to reduce her paycheck by a specified amount or percentage and put that money into her simple IRA.
But what if I can't afford that 3% match?
That could really pinch if times get rough.
You may reduce this 3% limit on the matching contribution to a lower percentage, but no lower than 1% for up to two calendar years out of five.
Let's look at examples.
The ABC company chose to make dollar for dollar matching contributions up to 3% of compensation to its calendar year SIMPLE IRA plan for each of its eligible employees.
Fred earns $30,000 and chooses to defer 10% of his salary or $3000.
ABC matches the first 3% of Fred's deferral and makes a contribution of $900 or 3%.
ABC then takes a deduction for those contributions.
ABC can't make any other employer contributions to the SIMPLE IRA plan for Fred.
ABC can change the formula for making employer contributions each year as long as it gives employees notice of the change by November 2nd , before the new calendar year.
There is also a limit on the amount an employee can defer from his or her salary for a calendar year.
Some of my employees have asked about a 401K plan.
A SIMPLE might be a good alternative since they can make contributions out of their pay.
The other employer option in the SIMPLE IRA plan is to make a contribution for each eligible employee of 2% of compensation.
This happens whether or not the employee chooses to make salary reduction contributions.
This is called a non-elective contribution.
Here's an example.
Frannie is a 25 year old employee of the XYZ company and is eligible for its SIMPLE IRA plan.
But this year she doesn't think she can afford to put anything into the SIMPLE IRA Plan out of her $20,000 pay.
XYZ will still make a contribution of $400 to her SIMPLE IRA account.
If Frannie leaves this $400 in her account until she's 65 years old, she'll have $1920 assuming a constant annual earnings rate of 4%.
If Frannie makes less conservative investment choices with a bit more risk, something that makes sense for a young person with many years until retirement her $400 could grow much more.
So now you've signed a written agreement, notified employees and set up IRAs for participants.
What's next?
Before November 2nd each year you'll tell employees how the plan will operate in the upcoming year and you'll give them a chance to make or change a salary reduction agreement.
If you start the plan during the year there are slightly different rules.
Check out IRS Publication 560, Retirement Plans for Small Businesses for those rules.
Employees can stop a salary reduction contribution at any time during the year and you can allow employees to add to the amount they are contributing at any time.
The November 2nd to December 31st 60 day election period is the minimum required for giving employees a chance to make salary reduction choices for the upcoming year.
Keep records of salary reduction agreements.
You'll cap the amounts of salary reduction contributions at the limit in effect for the year.
This usually changes each year and it's adjusted for the cost of living.
There are catch up provisions for employees 50 years of age and older.
In the lesson called " Managing your Payroll" you'll learn how to handle the payroll withholding for SIMPLE IRA contributions.
SEPs are pretty easy to understand.
Only the employer makes contributions to an SEP.
To set up an SEP you'll need to do three things.
Execute a written agreement, notify your employees, and establish traditional IRAs for your employees.
Carol, it doesn't get any easier than this.
The form and the instructions fit on a single sheet of paper.
Fill out the top part here, add your signature, title and date here, and you have your SEP Plan document.
Make a copy of the entire form and give a copy of the completed form and the instructions to each of your eligible employees.
Now there are a couple of other items that you'll need to tell your employees and they're listed in the instruction section of Form 5305 SEP.
Then you've met the employee notification requirements.
And then we can set up your employee IRAs and that's it.
You've got a SEP.
There are some employers who can't use Form 5305 SEP to set up their plan.
IRS publication 560 explains who falls in this category.
But an SEP can also be set up using a prototype document, these are usually provided by a mutual fund, insurance company, bank, or other qualified institution.
If you use an individually designed document you'll want to read IRS Publication 560 and perhaps talk to a tax professional to learn what other actions you'll need to take.
To finish setting up your SEP you'll need to set up IRAs for each eligible employee.
These SEP IRAs must be traditional IRAs rather than ROTH IRAs.
Employer contributions to an employee's SEP IRA can't be greater than 25% of the employee's compensation or the annual dollar limit, whichever is the smaller amount.
Compensation that may be considered for purposes of allocating the employer contribution is limited too.
These limitation amounts can be found in IRS Publication 560 or on our web site, www.irs.gov/ep.
There's more information about limits on SEP contributions when there is more than one retirement plan, or when self-employed individuals contribute to their own SEP accounts in IRS Publication 560.
You'll give each participating employee an annual statement showing the amount contributed to their SEP account for the year.
Your financial institution can help you with this.
Deduct the amount you contributed to eligible employee's SEP IRAs on your business tax return.
In the lesson called " Managing your Payroll" you'll learn how to handle the payroll withholding for SEP contributions.
There are some rules common to both SEP and SIMPLE IRA plans.
There's a tax credit for business owners of up to $500 per year for the first three years of an SEP or simple IRA plan for the costs of starting the plan and educating employees about the new plan.
You'll file form 8881 to claim this credit.
Employees may roll over their SEP or SIMPLE IRA into another plan.
Check out IRS publication 590 for more on these rules.
Employees can take a withdrawal from their SEP or SIMPLE IRAs at any time but there is an additional tax on early withdrawals, generally before the age of 59 1/2.
The IRA owner also must start taking minimum withdrawals from the IRA once they turn 70 1/2 and don't forget, no one can borrow from their IRA.
That's a lot to remember.
Running an SEP or SIMPLE IRA plan is actually easier than it sounds at first.
It's worth the effort for you, your family, and your employees.
We hope you'll visit our web site for more information about retirement plans.
We'd especially like to invite you to subscribe to our free electronic newsletter for employers.
This newsletter is valuable for business owners without employees too.
Lesson ten has a list of publications and web sites that we think may be helpful to you as you plan for your future.
For resources discussed in each lesson, please visit the Lesson 10 Supplement.
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