Although not required for small business owners in most states, small business IRAs are a great way for owners and their employees to save for their futures. There are two major accounts you can set up as a small business owner, each with different set-up requirements, flexible options, and employee participation rules. One is called the Simplified Employee Pension (SEP) IRA, and the other is called the Savings Incentive Match Plan for Employees (SIMPLE) IRA. Here are the most common questions small business owners have with regards to these two account options:
- What are the contribution limits of a SEP? All contributions to an employee’s plan must come from the employer. Employees cannot contribute to their SEP plans. The maximum contribution an employer can make to the plan is 25% of the employee’s salary, or up to $55,000 if 25% exceeds this amount. The same goes for your own account as the business owner.
- Do I have to contribute the same percentage for each employee? Yes. Many plans require you to choose a percentage you would like to contribute for each employee. If you choose 3%, everybody gets a 3% contribution no matter how much they earn. This can lead to different total amounts. Remember, whatever percentage you choose also applies to your own account.
- How do the tax deductions work? The contributions your business makes to each account don’t count toward the individual employees’ gross incomes. So, they won’t have to claim it as taxable income when filing. Contributions are tax deductible for the employer, including their own personal plan. The funds will grow tax deferred and the employees will pay income taxes on any distributions.
- What are the contribution limits of a SIMPLE IRA? An employer can choose to contribute 2% to all employees who earn at least $5,000, and up to $275,000 (2018) in income, or employers can offer up to 3% matching for employees who electively take a salary reduction contribution for their plans. In each case, the employee cannot contribute more than $12,500 to their plan per year, or $15,500 if older than 50. If the employer chooses to make 2% contributions, they must give this to every employee regardless of whether or not they make their own contributions to the plan.
- How does matching work? For employers who choose the matching plan (rather than the flat 2% plan), employees will decide how much of their income they would like to contribute directly into their SIMPLE IRA. The employer then matches up to 3% of their income into the plan. If the employee decides to contribute 2%, the employer will also match the 2%. If the employee decides to contribute 5%, the employer will only have the ability to match up to 3%.
How do the tax deductions work? Just like with SEP IRAs, employers can deduct contributions to a SIMPLE IRAs annually. The employee only pays the taxes on the distributions when they list it as taxable income on their tax returns.