Advanced Underwriting Consultants

Ask the Experts – June 12, 2014

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client is trying to decide between setting up a SIMPLE or SEP IRA for her small business. What should I tell her?

Answer: Without more details, you can only speak in generalities. You should start with the differences between the two.

A SIMPLE IRA (savings incentive match plan for employees) is very similar to a 401(k) plan in that it’s primarily a way for an employee to choose to contribute the employee’s money to a pension plan.

SIMPLE IRAs may include both employee deferrals and employer contributions. The employer must either (1) match the employee’s deferral dollar-for-dollar, generally up to 3% of the employee’s salary; or (2) make a 2% nonelective contribution to all eligible employees—regardless of whether the employee made a contribution.

An employee’s deferral limit for a SIMPLE IRA is $12,000 (in 2014, indexed for inflation).  The employee’s deferral must be deposited by the employer within 30 days from the end of the month in which the election was made, and the employer’s matching or 2% nonelective contribution must be made by the time tax returns are due in the following year.

To implement a SIMPLE IRA, an employer must have 100 or fewer employees who receive more than $5,000 per year. Every employee who earns at least $5,000 from the employer is an eligible employee and must be allowed to participate in the SIMPLE plan.

A SEP IRA (simplified employee pension) is easier to describe and implement than a SIMPLE IRA. It’s essentially an IRA set up on behalf of an employee to which the employer makes contributions based on a percentage of the employee’s compensation (the maximum compensation taken into account is $260,000 in 2014). The percentage contributed must be the same for every eligible employee.  There are no employee deferrals into a SEP plan.

An eligible employee is one who (1) is 21 years or older, (2) has worked 3 of the last 5 years or more, and (3) earned $550 in compensation. The contribution limit is 25% of the employee’s salary, or $52,000 (in 2014, indexed for inflation), whichever is lesser.

Understanding the differences between these plans can help your client decide which plan makes more sense. For example, if the business consists of only your client, the most important aspect is probably the contribution limits.

If the business generates relatively small amounts of income, a SEP IRA will limit the owner’s contribution. For example, let’s say your client has a side business bringing in $16,000 per year in salary. Under a SEP, the most he may contribute is $4,000 (25% of $16,000). On the other hand, with a SIMPLE IRA, he may make the full $12,000 contribution and have the business make a matching $480 contribution (3% of $16,000).

But if he earns $100,000 per year through his business, the business may contribute $25,000 (25% of $100,000) under a SEP, and he can only defer $12,000 (plus a $3,000 matching contribution from the business) under a SIMPLE plan.

Sources: I.R.C. § 408(k), (p); § 402(h)(2)(A).

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.

Ask the Experts – March 24

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client mistakenly rolled over funds from his traditional IRA to his SIMPLE IRA. Is there a way to correct this error without incurring any penalties or tax liabilities?

Answer: Yes, he can later recharacterize the amount as a contribution to another traditional IRA assuming the contribution was made via a trustee-to-trustee transfer and the recharacterization was made by the due date (including extensions) of his tax return for the year in which the contribution was made. Additionally, your client must:

    • Include in the recharacterization transfer any income allocable to the contribution.
    • Report the recharacterization on his tax return for the year during which the contribution was made.
    • Treat the contribution as having been made to the second IRA on the date it was actually made to the SIMPLE IRA.

Also, your client must notify the trustees involved of the recharacterization, and supply the trustees with certain information, including:

    • The type and amount of the contribution to the SIMPLE IRA that is to be recharacterized.
    • The date the contribution was made and the year for which it was made.
    • Directions for the SIMPLE trustee to transfer the original contribution to the trustee of the traditional IRA.
    • The name of both trustees.
    • Any additional information needed to make the transfer.

Form 8606 should be used to report the recharacterization.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.