Frequently Asked Questions
I do not have any employees, is there any way I can save more?
A SEP-IRA plan is a good choice for the self-employed. The maximum contribution for 2008 is $46,000 (or 25% of self-employment income whichever is more). Because a SEP-IRA contribution is considered an "employer" contribution, it is not subject to Social Security and Medicare taxes. If you are married and your spouse is not employed, they can still contribute the maximum to a Traditional IRA account. In addition, if your gross adjusted income is below $159,000 (married filing jointly), you can also have a Roth IRA account. However, with a SEP-IRA plan, if you have employees you must contribute the same percentage to all employees as you do for yourself. Keep in mind that each employee has an IRA account and all contributions are vested immediately.
I only have a few employees and a 401(k) plan seems too complicated and expensive?
A SIMPLE-IRA may be a good choice in this instance. Each employee (including you and your spouse) can defer up to $10,500 annually ($13,000 over age 50). As an employer, your only obligation is to match the 1st 3% of deferrals by all employees including yourself. For example, if you had an employee that earned $40,000, your match would be $1,200 as long as the employee contributed at least that amount. The limit on compensation for determining the match is $230,000. This would cap your maximum to $17,400 ($19,900 over age 50). The deferrals into the plan are also subject to Social Security and Medicare taxes. Often a SIMPLE-IRA is a good choice as an initial plan option for the first two or three years. The shortcomings of a SIMPLE are that all employer contributions are vested immediately and there is no ability to make additional contributions when you have a good year.
Is there a simple explanation of a 401(k) plan?
A 401(k) plan is actually a plan option in a profit sharing plan. A basic profit sharing plan is very similar to a SEP-IRA plan. Each eligible employee (generally one year of employment) gets the same percentage of their W-2 income placed into an account that may or may not be subject to a vesting schedule (employer option). A typical vesting schedule would be 20% after two years, 40% after three years, 60% after four years, 80% after five years, 100% after six years. A 401(k) plan is simply an option for every employee to defer up to $15,500 per year ($20,500 over age 50) within the profit sharing plan. The employer may elect to have some kind of matching formula on the 401(k) deferrals. The 401(k) option can be made available whether or not there are profit sharing contributions or matching contributions.
My employees probably won't contribute to a 401(k), where does that leave me?
Generally speaking, highly compensated employees (income over $105,000 or a 5% ownership in the business) are not allowed to make a deferral more than 2% above the average of the non-highly compensated employees. For example, if your employees averaged a 3% deferral rate, the maximum for highly compensated employees would only be 5%. In small groups, one person not deferring can have a very big impact. In most cases, an employer can offer a Safe Harbor 401(k) plan where all eligible employees receive a 3% contribution that is vested immediately. Under a Safe Harbor plan, all employees can contribute the maximum regardless of the participation level of the other employees.