The Big Easy
Simplified employee pensions -- a low-cost, no-hassle strategyto provide employees with retirement benefits
Bill Buckingham had a problem. His Buckingham Computer Services Inc. was based in Midland, Mich., a community of just 37,000. "Dow Chemical is the employer in town, and I knew as we grew I'd be competing against it for a limited supply of qualified workers. That was going to be hard," Buckingham explains, "because it has all kinds of employee benefits -- the kind I couldn't afford to offer if I wanted to keep funneling cash into growing my business."
It wasn't just a question of money. Buckingham felt he was over his head when it came to choosing between the myriad benefits that could be offered to the employees of his computer-training and -service business. Worse still, he knew that his company lacked the management resources to administer any of them internally. Fortunately, he came across a government pamphlet that described a plain-vanilla benefit known as the simplified employee pension (SEP) plan.
"I liked it from the start," he recalls. "It was so straightforward and simple to figure out that I could see it would take a little time to research it and make some decisions -- and then I'd be able to very quickly shift my attention back to what mattered, running and gunning my business."
Less than 20% of people employed by small companies have any type of pension coverage, according to the U.S. Small Business Administration, compared with more than 80% of those working for large corporations. That puts smaller businesses at a real disadvantage when it comes to hiring in competitive job markets, and Buckingham knew it.
Fortunately, SEPs, which operate like a cross between individual retirement accounts and corporate profit-sharing plans, offer an attractive alternative for growing companies. The paperwork and cost that are involved in setting up and administering SEPs are minimal. So are employer requirements. That means companies are free to adjust their annual contributions or even skip them entirely as business conditions warrant. Best of all, because of often-overlooked tax benefits, SEPs can actually improve bottom-line results for companies like Buckingham Computer.
Bill Buckingham started researching SEPs about five years ago, when his company had big growth plans but only 3 employees, including him and his wife. (The company, which made the 1988 Inc. 500 list, now has 55 employees, offices in five states, and $3 million in sales.) Although Buckingham didn't know much about the minutiae of employee benefits, he had formulated a checklist of requirements that made sense for his company.
"I wanted a plan that would be so simple and standardized that it would be easy for me to explain as a good thing to my employees or job candidates," he says. "I also wanted everyone to receive the same share, so there wouldn't be any hassles about fairness." Because Buckingham himself had been forced to sacrifice his retirement benefits when he stopped working for a large corporation, he wanted his employees to be able to take their funds with them if they decided to move on. "And since we were a young company, I didn't want to waste money on legal fees or administrative costs for running the program."
As he started talking to local brokerage houses about the plans they offered, it was clear that SEPs satisfied all of his basic requirements.
To see why, look at how a SEP works. Employers like Buckingham contract with a financial services organization (generally, a brokerage house, mutual fund company, or insurance firm) to administer what is known as a prototype SEP plan. Many providers will set up the plan at no cost to the company; they receive their income later in the form of annual administrative fees that are charged to participating employees, not to the employer. Because SEP plans are standardized, there's no need to hire a lawyer to write a costly plan description and file it with the Internal Revenue Service. In fact, all that's involved in starting a plan is providing the administrator with a list of qualified employees (generally those who have at least three years' tenure with the employer).
Once a plan is in place, employers make annual contributions as they wish to the retirement accounts set up in each employee's name. Contributions are tax advantaged in two important ways: they are tax deductible as a business expense, and, although they are a form of workers' compensation, they are free from any payroll taxes.
Employer contributions can range during any particular year from zero to 15% of each employee's salary, up to a maximum of $30,000 per employee. By law, though, every employee must receive the same percentage contribution, as long as he or she has worked for the company for three of the past five years and has earned at least $342 a year. (The minimum amount increases each year according to an inflation index.) Just as with IRAs or 401(k) accounts, employees must wait until they reach age 59½ to withdraw SEP funds or else pay tax penalties. If they switch jobs, they can roll over their SEP funds into IRAs without incurring any tax liabilities.
"Once the money goes into the employees' accounts, the company's obligations are over," says Buckingham. "It's up to the employees to decide how they want to invest the money in their accounts from a list of choices offered by the brokerage house, to which they pay the annual administrative fees. The brokerage house is contracted to administer the plan and handle whatever paperwork exists."
Employers aren't even required to fill out a separate tax form, the way they have to with a profit-sharing plan. All they report is a line-item deduction for SEP contributions on their tax returns.
Buckingham evaluated the plans offered by several local brokerage firms according to several factors: administrative and custodial fees (he didn't want his employees to get socked with excessive charges), breadth of investment options, and backup services.
Ultimately, he chose Merrill Lynch's model. Its fees were competitive, ranging from a minimum of $35 a year to a maximum of $100 a year, pegged according to the asset size of each account. The plan permitted his employees to diversify their accounts by selecting from virtually every investment Merrill Lynch brokers can offer, with the exception of ultrarisky commodities and precious metals. In addition, the brokerage house agreed to run annual workshops to explain the program to Buckingham's employees as they became eligible for coverage.
"That meant all I'd have to worry about each year was figuring out how much I wanted to contribute," says Buckingham, "and then write the checks."
To make certain the SEP never becomes a financial burden on the company, he waits until year-end results are in before fixing his contribution level. All contributions must be made by the corporate federal income tax filing deadline, including extensions, for the previous year.
"To date, we've been able to make the maximum contribution level of 15%, which added up to $59,996 last year. But I tell my employees that as we add staffers or continue to expand regionally, there may be years when we can't meet that level," he says. The company's tax savings for 1989 -- what Buckingham calls the SEP's "added incentive" -- amounted to $17,885.
Buckingham is convinced that the SEP has been a major ingredient in Buckingham Computer's successful growth strategy. "It's helped us retain our employees because it shows them that we're conscientious about satisfying their needs," he says. "And you can bet we play this up as a big benefit when we're interviewing a job candidate we really want to hire."
If you are looking for some good sources of information about SEPs, here are a few:
* "Simplified Employee Pensions (SEPs): What Small Businesses Need to Know" is a short but comprehensive brochure that is published by the Department of Labor and the Small Business Administration. To order, send $1 for GPO stock number 045-000-00256-0 to Superintendent of Documents, U.S. Government Printing Office, Washington DC 20402.
* "IRS Publication 590" offers further details, with an emphasis on tax issues. It can be ordered from the Internal Revenue Service at no charge by calling (800) TAX-FORM.
* "IRS Form 5305-SEP" illustrates a model SEP program. It also can be ordered from the IRS at no charge by calling (800) TAX-FORM.
A SEP CHECKLIST
Is the plan right for you?
SEP plans offer tremendous advantages for growing businesses. But because of their standardized nature and other features, they don't necessarily make sense for every company. Here is a checklist that will help you decide if they're right for you:
* Is your employee base small? If you have fewer than 100 employees and a simple list of requirements, a SEP would probably be a perfect fit for your company. For larger companies it pays to check out other plans, since overall administrative costs may be lower with, say, a 401(k) plan.
* Do you employ a lot of part-time workers or summer help? If so, a SEP may be unnecessarily costly, since you'll have to include any employee who has earned at least $342 a year from your company for three of the past five years. You might want to consider setting up a profit-sharing plan instead, since its threshold for inclusion is 1,000 hours of service within a year.
* Need to minimize corporate expenditures? Then a 401(k) plan might make better sense for your company, since employees will be able to save their own funds for retirement while earning tax benefits. And you'll be able to limit corporate matching contributions as long as necessary.