News & Events

Want to open an account?

Find an office.

September IRA Insights: Which Plan Better Fits the Needs of Your Business

By: Jack Kiley CPA, PFS

We receive many calls in our office from self-employed individuals who have already decided to self-direct their retirement. The challenge then becomes which one of our plans is the 'best' plan for them. For the self-employed (which includes sole proprietors, single member LLCs and sole shareholder corps), there are a couple choices. In addition to IRAs (both traditional and Roth), they may choose a Simplified Employee Pension (SEP) or an Individual(k) Plan.

A SEP plan is technically an IRA. The Government developed these plans to allow self-employed individuals to contribute to a ‘retirement plan' without many of the compliance and filing burdens required of retirement plans. An Individual(k) plan is a plan that Entrust designed specifically for the self-employed person who has no employees other than him or herself. These plans have qualified under IRS and Department of Labor guidelines as retirement plans. Both of these plans are offered by Entrust and allow you to self-direct.

Many factors should be considered when selecting which type of plan is best for you, including earnings and cash flow from the business, tax considerations and retirement goals. These are all factors the entrepreneur needs to discuss with his or her advisors prior to selecting a plan.

Most of the questions we get center on two issues-flexibility and ease of use.

Flexibility generally answers the following questions:

• "Which plan allows me to put more money in it?"
• "Are there other attractive features that I may find useful?"

The contribution question is easy to answer but complex to compute. For SEP plans, you are allowed to make a profit sharing contribution (for incorporated businesses- up to 25% of earnings and for unincorporated businesses-of up to 20%, of net earnings minus ½ of self employment tax). Individual(k) plans allow this profit sharing contribution as well and, in addition, allow what is called an 'elective deferral' of up to $15,500 in 2008 on earnings as previously defined. So, for example, your business generates net income of $75,000 after expenses. You would be able to contribute $15,000 into a SEP plan (20% of $75,000). In an Individual(k) plan you would also be able to contribute the same $15,000 AND an additional $15,500 as an elective deferral. (Think of this as the amount you defer from your 'pay' just as your friends do who work for big companies). This would allow a total of $30,500.

The Individual(k) plan also has few features that many self-employeds find interesting. First, you may borrow from the Individual(k) plan. You may borrow the lesser of (a) $50,000 or (b) 50% of your vested account balance. Second, you can elect to make the deferral contributions on a Roth basis. This means that the earnings derived from these contributions will be tax-free when you distribute them at retirement (and you will not get a current year tax deduction for the deferral amount). Additionally, there is no income limitation to making these contributions as there is when contributing to a Roth IRA (if you make >$150K, you are precluded from making a Roth IRA contribution). Lastly, again with respect to the elective deferral, there is something called a catch up provision. If you are older than 50, you may defer an additional $5,000 on either a Roth or Traditional basis. This would bring your total contributions up to $35,500 on $75,000 of earnings.

With respect to administering retirement plans, most business owners do not want to spend a lot of time or money. As you might expect, there are differences between the two plans and here are some of the major ones. SEPs are easier to administer than the Individual(k)s. You can set up the plan and make the contribution any time before filing your tax return (including extensions). The Individual(k) plan is more paper intensive and requires a little more planning than the SEP plan. First, you must have the plan established prior to the year end of the year for which you want to make contributions (plan year). This means the paperwork setting up the plan must be complete by December 31 of the plan year. There are several documents which you will need to complete and sign. Some of these you may want to go over with your advisors to be sure you understand them, so allow yourself some time. Any contributions made for the ‘elective deferral' need to be contributed ‘as soon as administratively feasible.' This has generally been considered to mean by January 15 of the year following the plan year. The profit sharing contribution, however, can be contributed any time prior to filing your tax return (including extensions) like SEPs. If your plan assets rise above $250K, your plan will need to file form 5500. This is not a difficult form to complete, but it is another administrative ‘to do.'

Generally, speaking, Individual(k) plans allow larger contributions and flexibility at a cost of more plan administration while SEPs offer just the opposite. You just need to figure out where you want to be on this continuum. For more information, refer to www.theentrustgroup.com as well IRS publications 560 and 590.

Jack Kiley is a Certified Public Accountant with a Series 65 license. He is a Partner of Entrust MidAtlantic, LLC., serving the states of Maryland, Virginia, District of Columbia, and the Eastern Counties of West Virginia.