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There are a variety of options available to self-employed individuals who are trying to save for retirement and to small businesses which want to help their employees save for retirement. The most popular options are SEP/IRA's, SIMPLE IRA's, and Keogh Plans. In certain instances, the SIMPLE IRA is the best choice by far. Anyone who plans on contributing to a SIMPLE IRA for 1998 needs to set one up prior to October 1, 1998.
Who would benefit the most by setting up a SIMPLE IRA?
Two groups of taxpayers should consider setting up a SIMPLE IRA versus setting up a SEP/IRA or a Keogh:
How much can be contributed to a SIMPLE/IRA each year?
A self-employed individual with net self-employment income greater than $6,000 is entitled to contribute as much as $6,000 plus 3% of net self-employment income. For example, a person with net self-employment income is $20,000 would be allowed to contribute as much as $6,600 ($6,000 + 3% * $20,000) to the SIMPLE.
The only condition which would reduce the amount of the allowable contribution is if the person contributed more than $4,000 to a 401(k) plan or 403(b) plan during the year. For 1998, the amount contributed to the SIMPLE plus the amount contributed to a 401(k) plan and/or a 403(b) plan cannot exceed $10,000.
An individual who is an employee of a small business who earns more than $6,000 can contribute as much as $6,000 to the SIMPLE each year. Employers who are thinking about offering a SIMPLE need to be aware of two issues. First, the employer is required to match a portion of the employee's contribution made into the SIMPLE. The amount of the matching contribution must equal the lesser of the employee's contribution or 3% of the employee's annual compensation. Second, in 1998, an individual cannot contribute more than $10,000 combined to a SIMPLE, 401(k) and 403(b) plan.
Are there any costs to the employer?
The only cost to the employer, as discussed above, is the amount that they are required to match each year on behalf of their employees. For example, if a company has 4 employees who each earn $20,000 annually and each contributes $1,000 to the SIMPLE, the company would be required to contribute $600 (3% * $20,000) into each employee's account. No matching contributions need to be made for employees who do not themselves contribute to the SIMPLE.
There are generally no costs to establishing or maintaining employer sponsored SIMPLE/IRAs. In addition, there are no annual tax returns which need to be filed.
Are there any other advantages to SIMPLE IRA's?
There is one other huge advantage to SIMPLEs. If a person is self-employed and has employees, and wants to put away a lot of money for retirement into a SEP/IRA or a Keogh, they must generally put away a lot of money for their employees as well. With a SIMPLE, contributions only need to be make on behalf of an employee if that employee elects to contribute a portion of their salary to the SIMPLE, and then, the amount of the contribution is limited to 3% of that person's compensation.
Additionally, if the employee elects not to contribute to the SIMPLE, the self-employed individual can still contribute as much as $6,000 plus 3% of the net employment earnings.
When are SEP/IRAs and Keogh plan preferable?
The maximum annual contribution to a SEP/IRA is 15% of a person's salary or 13.0435% of a person's net self-employment income. The maximum annual contribution to a Keogh is 25% of a person's salary or 20% of a person's net self-employment income. Generally, once someone's income exceeds $30,000, Keoghs and SEPs allow for larger annual contributions.
There is another advantage of Keoghs. IRAs, including SEPs and SIMPLEs, are considered non-qualified retirement plans and are at risk of being seized by one's creditors as a result of bankruptcy or a malpractice claim. Keogh's, on the other hand, are considered qualified retirement plans (in many instances) and are protected from one's creditors. For a Keogh plan to be considered a qualified plan, however, contributions must be paid on behalf of at least one employee; including yourself. Taxpayers who are organized as sole proprietorships cannot consider themselves as employees for this purpose.
How can a person establish a SIMPLE IRA?
SIMPLE's can either be set up directly with one of the large mutual fund companies or with the help of a financial advisor. Remember, the deadline for setting up a SIMPLE is 10/1/98.
What are the due dates for making contributions into the SIMPLE IRA?
There are actually 2 different due dates. The contributory portion of the SIMPLE IRA, which can be as much as $6,000 per year, MUST BE MADE PRIOR TO JANUARY 31ST OF THE SUBSEQUENT YEAR. The 3% matching contribution can be made as late as the due date of the tax return including extension. For most taxpayers, therefore, this means that this part of the contribution can be made as late as 4/15 of the following year.
Please don't miss this January 31st deadline. If you want to put the maximum amount away, you need to make sure to contribute the $6,000 on time. Most of the financial institutions were not accepting the SIMPLE IRA contributions if they were made subsequent to January 31st.
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