IRAs and 401(k)s: how to pick the best plan; help your firm - or your clients - make the right choice.EXECUTIVE SUMMARY
* RETIREMENT PLANS ARE OFFERED BY a variety of providers, including financial institutions, insurance companies and payroll service providers. But adherence adherence /ad·her·ence/ (ad-her´ens) the act or condition of sticking to something.
immune adherence to IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. regulations is the responsibility of the business owner.
* ANY BUSINESS WITH ONE EMPLOYEE that does not have any other type of retirement plan can set up a simplified employee pension-IRA plan. All contributions to SEPs come from the employer. SEPs are easy to set up and maintain, and do not require an annual tax return.
* THERE ARE TWO TYPES OF SAVINGS INCENTIVE match plans for employees: the SIMPLE IRA Simple IRA
A salary deduction plan for retirement benefits provided by some small companies with no more than 100 employees. and the SIMPLE 401(k). They require little documentation and no annual tax filing. But employers must make annual contributions to employee accounts. Employer and employee contributions both are vested vested adj. referring to having an absolute right or title, when previously the holder of the right or title only had an expectation. Examples: after 20 years of employment Larry Loyal's pension rights are now vested. (See: vest, vested remainder) immediately.
* THE TRADITIONAL 401(k) PLAN carries the most reporting requirements and is the most costly to administer. It is better for employees because they can make contributions every year, even if the employer does not. Administration of 401(k) plans is complicated by annual compliance testing and a required annual tax return.
* SAFE HARBOR Safe Harbor
1. A legal provision to reduce or eliminate liability as long as good faith is demonstrated.
2. A form of shark repellent implemented by a target company acquiring a business that is so poorly regulated that the target itself is less attractive. 401(k) PLANS are an attractive alternative for a business that wants a 401(k) plan, but does not want to or is not able to satisfy the annual discrimination testing Discrimination testing is a technique employed in sensory analysis to determine whether there is a detectable difference among two or more products. The test uses a trained panel to discriminate from one product to another. required by traditional plans. The price to be paid is a safe harbor contribution made to all employee accounts.
CPAs with small business clients--or those with decision-making responsibilities for smaller companies--often are called upon to evaluate pension plan options. This article will help by outlining the key features of retirement plans that can be implemented by small businesses: the simplified employee pension-IRA (SEP-IRA SEP-IRA Simplified Employee Plan - Individual Retirement Account ); the savings incentive match plan for employees (SIMPLE), IRA Ira, in the Bible
Ira (ī`rə), in the Bible.
1 Chief officer of David.
3 Two of David's guard.
IRA. and 401(k); the traditional 401(k); and the safe harbor 401(k).
The Economic Growth and Tax Relief Reconciliation Act (EGTRRA EGTRRA Economic Growth and Tax Relief Reconciliation Act of 2001 (also known as EGTRAA 2001) ) of 2001 offers tax credits to any business with 100 or fewer employees that establishes a pension plan. Such businesses are eligible for credit up to 50% of the first $1,000 spent on retirement education and administration, to a maximum of $500 per year for the first three years. Eligible employees must have received $5,000 in compensation, and there must be at least one "highly compensated" employee who owned more than a 5% interest in the business at any time during the previous year or who receives compensation of more than $95,000 in 2005 (increased from $90,000 for 2004).
The law also includes a provision enabling employees age 50 or older to "catch up" by making incremental Additional or increased growth, bulk, quantity, number, or value; enlarged.
Incremental cost is additional or increased cost of an item or service apart from its actual cost. contributions to compensate for any years in which they did not participate in a pension plan. Another provision offers a tax credit to low-income participants; they can receive a nonrefundable tax credit of up to 50% on up to $2000 in contributions to specified plans, for a maximum credit of $1,000. This credit is in addition to the tax deduction Tax deduction
An expense that a taxpayer is allowed to deduct from taxable income.
See deduction. already associated with contributions to such plans.
In order to ensure that all retirement plans have a representative balance of participants and are not dominated by higher-paid employees, they are subject to annual top-heavy testing (IRC (Internet Relay Chat) Computer conferencing on the Internet. There are hundreds of IRC channels on numerous subjects that are hosted on IRC servers around the world. After joining a channel, your messages are broadcast to everyone listening to that channel. section 416(g)). (See "Top-Heavy Testing and Key Employees," above.) If a plan becomes top-heavy, the employer must provide a minimum contribution to all nonkey employees, based on how much they have contributed to the plan--out of their own salaries or in the form of employer contributions--during the year. CPAs therefore should remind their small business clients that it's up to the plan administrator to keep a keen eye on account values throughout the plan year and notify the employer if the plan is in danger of becoming top-heavy.
To make it less likely that a plan would be deemed top-heavy, the EGTRRA narrowed the definition of key employees by nearly doubling the compensation limit from $67,500 in 2000 to $130,000 in 2001. It also allowed companies to count matching contributions Matching Contribution
A type of contribution an employer chooses to make to his or her employee's employer-sponsored retirement plan. The contribution is based on elective deferral contributions made by the employee. toward satisfying the minimum contribution requirements.
The top-heavy rules are particularly harsh on Verb 1. harsh on - criticize harshly; "the teacher keeps harshing on the same kid"
criticise, criticize, pick apart, knock - find fault with; express criticism of; point out real or perceived flaws; "The paper criticized the new movie"; "Don't knock the food--it's small businesses that employ family members; they discriminate dis·crim·i·nate
v. dis·crim·i·nat·ed, dis·crim·i·nat·ing, dis·crim·i·nates
a. by treating all family members as key employees, regardless of salary level and percentage of ownership (IRC section 318). This makes it difficult for family-based small businesses to pass top-heavy testing and continues to be a major deterrent de·ter·rent
Tending to deter: deterrent weapons.
1. Something that deters: a deterrent to theft.
2. to their implementing pension plans.
ONE SIZE DOESN'T FIT ALL
In recommending and researching retirement plan options, CPAs should pay special attention to the unique needs of the small business employer. (See "The CPA's Retirement Plan Checklist," page 40.) In addition to size constraints CONSTRAINTS - A language for solving constraints using value inference.
["CONSTRAINTS: A Language for Expressing Almost-Hierarchical Descriptions", G.J. Sussman et al, Artif Intell 14(1):1-39 (Aug 1980)]. , individual businesses face varying earnings, profit levels, number and age of employees, industry, business location, employee turnover, regulations, etc. A major concern is the uncertainty of future revenues. Without reliable, consistent earnings, a business cannot support a plan that requires an annual commitment to contributions by the employer. Pension plans are far from a "one-size-fits-all" product. CPAs should ensure that any plan selected is well-suited for the individual needs of the employer under its current circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact.
2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or and that it is flexible enough to remain effective if circumstances should change.
RETIREMENT PLAN OPTIONS
To give CPAs some insight into the challenge facing their small business clients, we asked six pension plan providers (financial institutions, insurance companies and payroll service providers) for recommendations in selecting a plan for a business with 10 full-time employees and an estimated annual payroll of $450,000 to $600,000. We used 10 employees because it was representative of employers that statistically have not provided plans. We selected the payroll total by using average annual earnings of small business employees of $30,000, and a supplement of approximately $150,000 for one or two more highly compensated owner/executives.
Five of the providers recommended a SEP-IRA, SIMPLE IRA or SIMPLE 401(k) and one suggested either a safe harbor or traditional 401(k) plan. Although pensions are usually implemented and maintained by plan providers, CPAs can assist their clients or employers in the selection process.
Here's a rundown Rundown
A summary of the amount and prices of a serial bond issue that is still available for purchase.
A list of available bonds in a municipal issue of serial bonds. of the options:
Best suited for: Small businesses that do not have any other type of retirement plan, have a small part-time staff and are comfortable completely funding the company pension plan.
Plan details. Small businesses can set up a SEP-IRA plan by completing IRS form 5305-SER or its equivalent, which may be obtained from any retirement plan provider. The IRS form requires a calendar-year plan while non-IRS forms permit businesses to opt for a fiscal-year plan instead.
A SEP-IRA is based only on employer contributions. The 2004 maximum annual contribution was 25% of the employee's compensation or a maximum of $41,000 ($42,000 for 2005). Vesting Vesting
The process by which employees accrue non-forfeitable rights over employer contributions that are made to the employee's qualified retirement plan account.
Notes: is immediate. Any employer with one or more employees may establish a SEP-IRA. Any employee who is at least 21, has been employed for three of the five preceding years and has earned a minimum of $450 in the current year is eligible to participate.
There are three formulas that may be used to allocate contributions to a SEP-IRA: a flat dollar amount, a specified percentage of eligible compensation or a Social Security integration formula. With the first formula each employee receives a contribution of the same dollar amount. Under the second formula, every employee receives a contribution of the same percentage of eligible compensation. If the employer decides on 10%, then all employees receive a contribution amounting to 10% of their eligible compensation, not to exceed the IRS limitation of $41,000.
Using the Social Security integration formula, the employer assigns Individuals to whom property is, will, or may be transferred by conveyance, will, Descent and Distribution, or statute; assignees.
The term assigns is often found in deeds; for example, "heirs, administrators, and assigns to denote the assignable nature of to the plan a percentage of the accumulated ac·cu·mu·late
v. ac·cu·mu·lat·ed, ac·cu·mu·lat·ing, ac·cu·mu·lates
To gather or pile up; amass. See Synonyms at gather.
To mount up; increase. total of all eligible employees' compensation, then, using a special formula, allocates a percentage to each eligible employee. The allocation must be made according to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. specific IRS-provided requirements or the SEP 1. SEP - Someone Else's Problem.
2. (tool) SEP - A SASD tool from IDE. may be disqualified dis·qual·i·fy
tr.v. dis·qual·i·fied, dis·qual·i·fy·ing, dis·qual·i·fies
a. To render unqualified or unfit.
b. To declare unqualified or ineligible.
2. . Social Security integration provides the higher-paid employees with a larger percentage of the contribution.
Plan advantages. SEP-IRAs are easy to set up and maintain and no annual tax return is required. The employer contribution is optional, which eliminates the problem of required contributions in years when cash flow is a problem.
Plan disadvantages. Employee accounts are completely funded, or not, by the employer. Part-time employees and those who have earned only $450 in annual compensation and met other minimal requirements must be included.
Best suited for: Small businesses that have a consistent, reliable, positive earnings stream.
Plan details. There are two types of SIMPLE plans: a SIMPLE IRA and a SIMPLE 401(k). For both types, employees may contribute up to $9,000 for 2004 and $10,000 for 2005; the catch-up contribution for employees age 50 and older is $1,500 for 2004 and $2,000 for 2005. In SIMPLE IRA plans the employer must match up to 3% of employee pay or make a 2% nonelective contribution Nonelective Contribution
A type of contribution an employer chooses to make to each of his or her eligible employee's employer-sponsored retirement plan. The contribution is not based on salary reduction contributions made by the employee. . In SIMPLE 401(k) plans the employer also must match the first 3% of deferred compensation.
Plan advantages. SIMPLE plans require little documentation and no annual tax filing. A plan is established by completing IRS form 5305-SIMPLE or an equivalent obtained from a retirement plan provider. Again, the non-IRS form permits a fiscal-year plan while the IRS form requires a calendar year. Employer and employee contributions are both vested immediately.
Plan disadvantages. Because of the annual mandatory employer contribution to employee accounts, employers who have concerns about irregular HEIR, IRREGULAR. In Louisiana, irregular heirs are those who are neither testamentary nor legal, and who have been established by law to take the succession. See Civ. Code of Lo. art. 874. earnings streams must be wary of SIMPLE plans. It is possible to reduce the contribution percentage in designated years, but not to zero.
Traditional 401(k) Plans
Best suited for: Small business clients with irregular earnings streams that cannot support a plan with required contributions.
Plan details. Established about 20 years ago, the traditional 401(k) carries the most reporting requirements among the plans discussed here and is the most costly to administer. Employees make contributions to their 401(k) plans from pretax pre·tax
Existing before tax deductions: pretax income.
pretax adj [profit] → vor (Abzug der) Steuern earnings. Employers can offer matching contributions but are not required to do so unless there is an imbalance imbalance /im·bal·ance/ (im-bal´ans)
1. lack of balance, such as between two opposing muscles or between electrolytes in the body.
2. dysequilibrium (2). in the plan that favors highly compensated employees. Employers may contribute a flat dollar amount, a share of the profits or a matching contribution.
Both SIMPLE and 401(k) plans are free from federal taxation but are subject to FICA FICA
Federal Insurance Contributions Act
Noun 1. FICA - a tax on employees and employers that is used to fund the Social Security system
income tax - a personal tax levied on annual income
and Medicare contributions. The traditional 401(k) plan is better for employees because it allows them to control the amount being set aside for retirement. Even if the employer chooses not to contribute in any particular year, employees still can. Employees also can contribute more to a 401(k) plan than they can to a SIMPLE plan. For 2004, 401(k) plan participants Plan participants
Employees or other beneficiaries who are eligible to receive benefits from a company's employee benefit plan. can contribute up to $13,000, plus an additional $3,000 per year catch-up contribution if they are 50 or older and meet additional requirements. For 2005, the maximum contribution is $14,000 plus a $4,000 catch-up. Employee contributions are vested immediately, while employer contributions may vest over time, according to plan schedules. If required contributions are made because the plan is top-heavy, the plan must adhere to adhere to
verb 1. follow, keep, maintain, respect, observe, be true, fulfil, obey, heed, keep to, abide by, be loyal, mind, be constant, be faithful
2. an accelerated vesting schedule Vesting Schedule
Schedule setting forth when, and to what extent, options become exercisable or restricted stock or stock units are no longer subject to forfeiture (for example, 20% per year over five years). outlined by the IRS, unless the plan's vesting schedule is more liberal.
401(k) costs. Administration of a 401(k) plan is complicated by the need for an annual tax return and annual compliance testing. Many small business employers turn the administrative duties over to the plan provider, but even if they do the IRS says it is the employer's responsibility to ensure that the plan is administered properly and fairly.
The plan providers we contacted said a 401(k) plan for a 10-employee company costs approximately $2,000 per year to administer, not including initial set-up costs or the cost of loan features. Some providers charge a per employee fee for administration in addition to monthly, quarterly or annual fees. Internet-based providers charge lower fees, and they predicted that fees will continue to fall as administration becomes more and more Internet-based.
The 401(k) plan was not a very popular choice for small business owners in the past because of its higher administration cost and the complexity of annual testing and filing of form 5500. Several plan providers we contacted suggested that small businesses consider outsourcing (1) Contracting with outside consultants, software houses or service bureaus to perform systems analysis, programming and datacenter operations. Contrast with insourcing. See netsourcing, ASP, SSP and facilities management. retirement plans to their payroll plan administrator, who already has access to the necessary payroll data. This reduces the cost to the employer and allows the employer and employees to deal with only one entity for both services.
Another way to keep costs down is to offer only a few carefully selected mutual funds as investment vehicles instead of a large variety. A study by the Pension Research Council showed that retirement plan participation was higher in plans that offered a handful of options, as opposed to 10 or more choices.
401(k) compliance tests. 401(k) plans are subject to top-heavy tests in addition to others specified by the IRS to ensure they maintain a balanced participation of highly compensated and non-highly compensated employees. IRC section 415 limits the annual amount that can be added to a participant's account from all sources for 2005 to the lesser of their entire earnings or $42,000; for 2004 it was the lesser of their entire earnings or $41,000. IRC section 404 limits the maximum an employer can contribute to 25% of the company's payroll.
Compliance tests such as the actual deferral deferral - Waiting for quiet on the Ethernet. percentage test (ADP (1) (Automatic Data Processing) Synonymous with data processing (DP), electronic data processing (EDP) and information processing.
(2) (Automatic Data Processing, Inc., Roseland, NJ, www.adp. test--IRC section 401(k)(3)) and the actual contribution percentage test (ACP (Associate Computing Professional) The award for successful completion of an examination in computers offered by the ICCP. It is geared to newcomers in the computing field. For more information, visit www.iccp.org.
ACP - Algebra of Communicating Processes tests--IRC section 401(m)(2)) prevent employers from designing 401(k) plans that benefit only highly paid personnel.
The ADP test compares the percentage of salaries the different classes of employees have contributed to the plan. The ACP test compares the percentage of employer contributions in the 401(k) accounts for the different classes of employees. If contributions for highly compensated employees are more than the test limits, the employer may have to pay a 10% excise tax Excise Tax
1. An indirect tax charged on the sale of a particular good.
2. A penalty tax applied to ineligible transactions in retirement accounts. This penalty is assessed by and paid to the IRS.
1. (see IRC section 4979).
IRS publications 4224 and 4050 provide information on correcting plans that are not in compliance so they maintain their tax-favored status.
Plan advantages. Employers are not required to contribute to the plan unless it is top-heavy. Employers wishing to contribute have the choice of making a matching contribution, profit sharing profit sharing, arrangement by which employees receive, in addition to their wages, a share of the net profits of a business. The purpose is to give them an incentive to increase their output through enhanced morale, less wasteful use of materials, better care of or a flat dollar contribution. Employees have the advantage of contributing pretax dollars to their accounts, which are vested immediately. The 401(k) plan allows for the highest permissible per·mis·si·ble
Permitted; allowable: permissible tax deductions; permissible behavior in school.
per·mis employee deferral of income and the highest catch-up contributions of all the plans.
Plan disadvantages. Administration costs are the highest of all the plans and require the most complex testing. In addition, the employer must file an annual tax return for the plan.
The Safe Harbor 401(k)
Best suited for: Employers with consistent earnings streams that can support a plan with annual required contributions. This is an attractive alternative for the business that wants the benefits of a 401(k) plan but does not want to or is not able to satisfy the required annual compliance testing. It's a very good option for family-based businesses that can meet the required criteria.
Plan details. The safe harbor plan is a means provided by the IRS to permit employers to achieve balanced participation in a 401(k) plan without the need for compliance tests. Rather, employers must make matching contributions to employee retirement accounts, or nonelective contributions (which are immediately vested) equal to 3% of each employee's annual compensation. The contributions are nonelective because they are made to all eligible employees, regardless of whether they participate in the company's 401(k) plan.
Matching contributions are made only to the accounts of active 401(k) plan participants. A dollar-for-dollar match must be made on salary deferrals up to 3% of compensation for each non-highly compensated employee, and a 50-cent-on-the-dollar match must be made on salary deferrals from 3% to 5% of compensation. The rate of any matching contributions being made to highly compensated employees cannot exceed that being made to non-highly compensated employees.
Employers choosing to make nonelective contributions can decide as late as 30 days before the end of each plan year whether to take the safe harbor route. Employers opting for the matching contributions must inform employees no later than 30 days before the beginning of the plan year, so they have time to determine their contribution rate.
Plan advantage. Offers all the benefits of traditional 401(k) plans but does not require mandated testing. Can be set up just 30 days in advance of the new plan year.
Plan disadvantage. Required annual contributions are the premise of this plan, so it is not a good option for CPAs to recommend to employers that do not have consistent earnings.
THE ROLE OF THE CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000.
Since most people focus on the short term, it's easy to lose sight of the future benefits that retirement planning Retirement financial planning refers to a collection of systems, methods, and processes which, in their aggregate, support a family unit's (client's) desire to achieve a state of financial independence, such that the need to be gainfully employed is optional. yields until it's too late. CPAs have a responsibility to educate small business employers and employees of the benefits of joining a retirement plan to the company and its employees.
CPAs should remember when advising small business clients that the best way to present information is in a brief and simple fashion. Small business owners often are bound by strict time constraints In law, time constraints are placed on certain actions and filings in the interest of speedy justice, and additionally to prevent the evasion of the ends of justice by waiting until a matter is moot. because of their limited staff. The key is to inform these clients without overwhelming them. The involvement and support of employers is imperative for promoting confidence in the plan and its sponsor.
Small Business Retirement Plan Options Plan SEP Simple-IRA Most suitable Are willing to Have consistent, for companies fund entire plan, reliable earnings. that: have small part-time staff. 2005 contribution limits: Employee None $10,000 Employer Nonobligatory. Match up to 3% Lesser of 25% of employee pay of employee or make 2% compensation nonelective or $42,000. contribution. Catch-up contribution None $2,000 Plan Simple-401(k) Traditional 401(k) Most suitable Have consistent, Have irregular for companies reliable earnings. earnings and that: cannot commit to regular contributions. 2005 contribution limits: Employee $10,000 $14,000 Employer Match up to 3% Nonobligatory. of employee pay Lesser of 25% or make 2% of employee nonelective compensation contribution. or $42,000. Catch-up contribution $2,000 $4,000 Plan Safe Harbor 401(k) Most suitable Have consistent, for companies reliable earnings that: but prefer not to undergo compliance testing. 2005 contribution limits: Employee $14,000 Employer Match each dollar up to 3% deferral and 50% for 3%-5% deferral or nonelective contribution of 3% of annual compensation. Catch-up contribution $4,000
See American Institute of Certified Public Accountants (AICPA). Resources
* The CPA's Guide to Retirement Plans for Small Businesses (paperback # 017237JA; paperback and software # 017239JA).
* Retirement Planning Conference, June 2005, Las Vegas Las Vegas (läs vā`gəs), city (1990 pop. 258,295), seat of Clark co., S Nev.; inc. 1911. It is the largest city in Nevada and the center of one of the fastest-growing urban areas in the United States. .
For more information or to order go to www.cpa2biz biz
Noun 1. .com, or call the Institute at 888-777-7077.
Small Businesses Offering Retirement Plans
Only 34.4% of firms with fewer than 25 employees offered retirement plans to their employees.
Source: Congressional Research Service The Congressional Research Service (CRS) is a branch of the Library of Congress that provides objective, nonpartisan research, analysis, and information to assist Congress in its legislative, oversight, and representative functions. U.S. , 2004, www.pensioncoverage.net/pdfs/purcell2.pdf.
Top-Heavy Testing and Key Employees
A "key employee" is one who at any time during the preceding plan year was:
* A 5% owner
* A 1% owner whose annual compensation exceeded $150,000
* An officer receiving more than $130,000 in compensation.
The IRS considers a plan "top-heavy" if the account values for key employees exceed 60% of the account values for all employees. For example: A small business employs a total of 11 people, three of whom meet the criteria for "key employees." If the account values for the three key employees total $15,000, while the account values for all 11 employees total $24,000, the plan would be considered top-heavy because the account values for the key employees equals 63% of the account values for all employees.
The CPA's Retirement Plan Checklist
* Get the facts together. Prepare a fact sheet of key company data including annual profit for the past 5 to 10 years, annual payroll costs (wages and services), number of full- or part-time staff, hours worked by part-time employees, ages of employees, turnover rates.
* Do your research. Educate small business owners about the different retirement products available and their tax implications. You can find useful information on the IRS Web site or the Internet as well as from plan providers.
* Contact several plan providers. It's best to shop around to identify the provider that will best satisfy your clients' needs.
* Consider bundling services. Recommend that clients contact their insurance providers or payroll services regarding pension plans. Bundling these services together may result in dramatic cost savings.
* Ask questions. CPAs can play a key role as liaisons between their clients and pension plan providers. Small business owners are better equipped to select a plan when they understand each one's unique features, and the provider's willingness and ability to answer questions provides some insight into their future working relationship.
CYNTHIA SCARINCI is assistant professor of accounting at the College of Staten Island History
It was established in 1976 from the merger of Richmond College (opened in 1965) and Staten Island Community College (opened 1956). Richmond College had been threatened with closure because of New York City's financial crisis, while the older school, because of its , The City University of New York The City University of New York (CUNY; acronym: IPA pronunciation: [kjuni]), is the public university system of New York City. . Her e-mail address See Internet address.
e-mail address - electronic mail address is email@example.com.