The owner of a small subcontracting company was feeling the squeeze. Some new competitors had sprung up in his market and he knew that paying his workers wages alone might not be enough to keep them. He also needed to start setting aside some funds for his own retirement, something he’d long procrastinated on. He sat down with his CPA to discuss the matter.
His accountant immediately thought of one vehicle he should consider: a Simplified Employee Pension plan paired with an IRA (SEP-IRA). It’s an easy way to set aside retirement money for both a small business owner and his or her employees without having to make a long-term commitment to fund it every year.
His CPA explained that a SEP-IRA is especially great for companies with cash flow issues or in industries that are cyclical by nature, like construction. Why? Employers can make larger payments in good years and reduce their contributions — down to zero — during down times. Plus, it could lower his company’s tax bill because every dollar placed in the fund directly reduces taxable income.
How it works
According to his CPA, any business owner or self-employed individual can open a SEP-IRA. For businesses with employees, an account is set up for each eligible person, which is typically someone who:
- Is at least 21 years old,
- Has worked for the company for three of the last five years, and
- Has received at least $600 in compensation during the year.
“Although employees are always 100% vested and have ownership of their accounts,” the contractor’s CPA said, “only you, the employer, can make contributions.” The contribution rate must be the same for all employees, including the business owner (up to 25% of the employee’s pay, but no more than $56,000).
A SEP-IRA account is a traditional IRA, the CPA further explained, and follows the same investment, distribution and rollover rules. Contributions are 100% tax-deductible, and employees don’t get taxed for money in the account until withdrawal.
“These accounts are appealing to small business owners like you,” his CPA said, “because they’re easy to establish and administer.” Employers don’t have to file annual returns, and SEP-IRAs don’t have the start-up and operational costs associated with conventional retirement plans, such as 401(k)s.
Lo and behold
After further discussion and due diligence, this contractor decided to implement a SEP-IRA for his construction company. Lo and behold, the advantages certainly manifested themselves. Not only was he finally saving for retirement, but his employees were, as well. Best of all, he held on to his skilled workers and even noticed an uptick in morale and productivity.
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