Ira's And Sep's: Retirement Plans Made Easy

New changes in the lawmake payroll-deduction Individual Retirement Accounts and Simplified Employee Pensions a corporate option worth considering.

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The government's new, liberalized rules on Individual Retirement Accounts (IRAs) can benefit your business in ways you may not have considered. Two programs now merit serious consideration by most small firms: Payroll-deduction IRAs can give your company a workable, uncomplicated retirement plan at no cost to the firm, and Simplified Employee Pensions (SEPs) can provide a company-funded retirement plan with few of the administrative requirements that ordinary plans have.

As of January 1, 1982, the Economic Recovery Tax Act abolished a rule that prohibited deposits from being made in a person's Individual Retirement Account while he was also covered by a conventional pension plan. The new tax law also dramatically increased contribution limits.

Payroll-deduction IRAs -- which existed before but remained rare -- have become significantly more practical. When only people without conventional pension plans could contribute to IRAs, few financial institutions knew how to set up payroll-deduction IRAs. Such accounts also caused complications if a company decided to establish a conventional plan. It was then forced to freeze everyone's IRA. A company couldn't launch a conventional plan in a year when it had already deposited money in anyone's IRA. And if an employee with a payroll-deduction IRA moved to another company that had a conventional pension plan, he couldn't enter the other company's plan until the following year.

Now all these problems are removed. Anyone can have an IRA. An employer can sponsor accounts for employees simply by deducting money from employees' paychecks and depositing it in an account the company helps them set up. Employees will be able to deduct the deposits on their federal income tax returns, reducing their taxes. The new law raises the maximum a person can deduct from $1,500 to $2,000 a year -- or $2,250 for an individual whose spouse does not work. Employers who currently sponsor pension plans should be aware that the new tax act also makes it legal for an employee to make up to $2,000 a year in voluntary tax-deductible contributions to the employee plan if the employer allows it.

Simplified Employee Pensions allow much larger tax-deferred contributions per person -- the maximum has just been doubled, so you can now contribute up to $15,000 or 15% of total compensation, whichever is less, each year. Under a SEP plan, a company establishes special SEP Individual Retirement Accounts for its employees and deposits the company's own money in them. This eliminates several complexities you'd face in establishing an ordinary pension plan. The Internal Revenue Service requires you to file only a one-page form to establish a SEP. You don't need to consult an actuary or run up a big bill with an accountant. You do need to keep an eye on the financial institution receiving the money, to make sure it's responsible, and you have to tend to a variety of administrative details. But because the money goes directly into an account in the employee's name, he is primarily responsible for supervising its management. He can even shift the money to another institution or take it out immediately, though in the latter case he'll have to pay a penalty tax.

All employees 25 or older who have worked for the firm in at least three of the preceding five years must agree to participate if you want to set up a SEP, but there's no good reason why an employee should refuse to let you deposit hundreds of tax-deferred dollars in an account with his name on it.

You can "integrate" the SEP with the employee retirement contributions you're already making under Social Security. That reduces the plan's costs without significantly cutting the benefits to you and other highly paid key people. Integration means reducing an individual's pension contributions by an amount equal to what you're already paying in Social Security tax. Suppose you're contributing 15% of compensation to a SEP plan and for a particular employee that would mean a pension contribution of $1,500. If you were already paying $670 in Social Security taxes for him, you could reduce your company's contribution to his SEP account to $830. For highly paid people the Social Security tax is a much smaller share of total compensation, so integration will not reduce the SEP contribution so much.

Here's the best part: You don't have to decide what percentage of compensation or even whether you're going to make SEP contributions for any calendar year until April 15 of the following year. That means that if you're using a calendar fiscal year you can wait and see how much tax you would owe without any SEP contribution, then make the contribution large enough to reduce your taxable profits by whatever amount you desire. As long as you have more than $100,000 in taxable income, for example, you'll save 46 cents in taxes for each dollar you contribute.

Moreover, an individual can both contribute money to his ordinary IRA and be the recipient of a SEP-IRA contribution from his employer in the same year. If your total compensation exceeds $100,000 a year, for example, you could shelter $17,000 a year with the two programs.

The catch in both programs is that people can't touch the money in their IRAs without dealing with the Internal Revenue Service. Whenever they take the money out, they must add the withdrawal to their income for that year. If a person withdraws money before he's 59 1/2 years old, he must pay an additional 10% penalty tax. And starting at age 70 1/2 an individual must each year take out -- and pay taxes on -- an amount at least equal to the total value of the account divided by his life expectancy as calculated by the IRS.

These tax rules mean an IRA may hurt a person who can't leave the money untouched until retirement. It could even hurt someone who leaves the money in the account until retirement, but then finds he's significantly more prosperous -- and thus in a higher tax bracket -- than he was when he deposited the money.

Don't expect the IRS to explain the system or even provide the proper forms to file. Bradley Schiller, an American University economist who has done studies of the Social Security system for the U.S. Congress, asked the IRS for information on setting up a SEP last year, before the law was liberalized. Schiller runs Capitol Research, a 12-employee consulting firm. The IRS bureaucraft Schiller's staff contacted made "simplified" pensions sound about as difficult as a public offering of stock in Outer Mongolia. The IRS had run out of the appropriate forms. It didn't know when it would have more. And anyway, the official said, the agency hadn't completed the guidelines on what kinds of investments were permitted.

The lesson is: Depend on a plan made available by, and forms supplied by, a financial institution that expects to make money from handling your employees' investments. That means generally a bank, a brokerage house, or a mutual fund.

The choice of institution will be important for your employees because, although once an employee's account is established with an institution he can shift it to another without paying tax, the procedure may be complicated.

Banks let you maintain Individual Retirement Accounts without a high fee, but the growth potential of a bank account is obviously limited.

A brokerage firm will probably suggest your employees' money be invested in mutual funds that pay a commission to the seller. You may be able to negotiate lower-than-normal commissions because of the number of accounts you will be opening, and the commissions are likely to be worthwhile if you don't have time to monitor the plan closely. The broker can advise the employees about how the accounts should be invested and handle such minor administrative tasks as changes of address.

But the cheapest way to invest an IRA in something with more growth potential than a bank account is through a no-load mutual fund manager such as those listed on this page. A call to an "800" number will bring you an extensive package of material on how to invest, and most funds -- whether they pay salesmen's commissions or not -- will give you additional guidance over the telephone. It probably won't be as easy to set up a plan using these packages as it would be through a bank or a brokerage house, but the no-load mutual funds won't charge your employees purchase or sales charges (though they have to take a management fee -- perhaps half a percentage point of the assets in an account per year -- to keep themselves in business).

If you want to integrate contributions to a SEP plan with Social Security to channel the benefits toward the best-paid people in your firm, make sure the institution you're dealing with has structured a plan so that's possible.

But no matter how you use SEPs you can't do everything with them that you might like. A business owner can't, for example, shelter large chunks of income for a few years prior to retirement as effectively as he could if he had a special pension consultant develop a defined benefit plan. Actuaries can often structure plans so virtually all the tax-sheltered money the company pays into the plan goes to providing benefits for the owner in the years after he retires.

You can't accomplish a trick like that without using a high-priced consultant. But it's hard to blame Congress for requiring that simple plans benefit employees as well as owners. If you're looking to provide a simple, modestpriced employee benefit, and perhaps to shelter a significant amount of your own income in the bargain, there may be no two better ways than with payroll-deduction Individual Retirement Accounts and Simplified Employee Pensions.