Continuing with more detailed descriptions from my Small Business Retirement Plans Quick List, the next plan I wanted to detail was the Savings Incentive Match Plan for Employees, or as it is more commonly known, the SIMPLE IRA. Just as the name suggests, it is a Simplified plan. Here I will discuss the SIMPLE IRA from the employer and the employee perspectives highlighting the pros and cons of each.

What is a SIMPLE IRA and How Does it Work?

In order to have a SIMPLE IRA plan, you must be a small business - generally, you must have 100 or fewer employees. However, there is a 2-year grace period for growing employers to still be considered a small business even if they go over the 100-employee limit. If you do opt for a SIMPLE IRA plan, your employees can elect to defer part of their salary. Each employee is immediately 100% vested in (or “owns”) all contributions to his or her SIMPLE IRA.

A SIMPLE IRA plan is a Savings Incentive Match Plan for Employees. Because this is a simplified plan, the administrative costs should be lower than for other, more complex plans. Under a SIMPLE IRA plan, employees and employers make contributions to traditional Individual Retirement Arrangements (IRAs) set up for employees (including self-employed individuals), subject to certain limits. It is ideally suited as a start-up retirement savings plan for small employers who do not currently sponsor a retirement plan.

Employers MUST make contributions, however employees can if they would like.

Setting Up a Simple IRA

The process behind establishing a SIMPLE IRA is incredibly easy. It only requires a couple of forms to get it up and running. A SIMPLE IRA can only be established if you have fewer than 100 employees and no other current retirement plan available.

Step 1: Contact a retirement plan professional or a representative of a financial institution that offers retirement plans. Many financial institutions will probably have a pre-approved SIMPLE IRA plan form that you can review.

Step 2: Choosing a financial institution to maintain employees’ SIMPLE IRAs is one of the most important decisions you will make, since that entity becomes a trustee to the plan. (Alternatively, you can decide to let employees choose the financial institution that will receive their contributions.)

Regardless of who makes the choice, only the following institutions can be designated as trustees of SIMPLE IRA plans: banks, mutual funds, insurance companies that issue annuity contracts, and certain other financial institutions that have been approved by the IRS.

Trustees agree to:

a) Receive and invest contributions, and

b) Provide the employer with a summary description of the plan features each year.

Step 3: Choose a model form or other plan document offered by your financial institution. If your financial institution offers a model SIMPLE IRA plan document, you will have a choice of two forms to use:

a) IRS Form 5304-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) - Not for Use With a Designated Financial Institution; or

b) IRS Form 5305-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) - for Use With a Designated Financial Institution.

The model form you use will depend on whether you decide to select the financial institution that will receive contributions or to let your employees select financial institutions.

c) If employees are allowed to select the financial institutions that will receive their SIMPLE IRA plan contributions, you will fill out Form 5304-SIMPLE.

d) If you require that all contributions under the SIMPLE IRA plan be initially deposited with a designated financial institution, you will fill out Form 5305-SIMPLE.

Your choice of the employees covered will be set out in your selected plan document. You can choose to cover all employees without restriction. Alternatively, you can limit the employees covered to those who received at least $5,000 in compensation during any 2 years prior to the current calendar year and who are reasonably expected to receive at least $5,000 during the current calendar year.

Step 4: Complete and sign the selected IRS form (or other plan document, if not using a model form). When it is completed and signed, this document becomes the plan’s basic legal document, describing your employees’ rights and benefits. Do not send it to the IRS; instead keep it handy.

Employee Eligibility for a SIMPLE IRA

Eligibility for a SIMPLE IRA is any employee who has made $5,000 or more in the previous 2 years, and who is expected to earn at least $5,000 this year.

SIMPLE IRA Contribution Limits

Employee - $10,500 in 2007 and 2008. If the employee is age 50 or over, a “catch-up” contribution is also allowed. This additional catch-up contribution amount is: 2007 and 2008 - $2,500.

Employer - Generally, a dollar-for-dollar match up to 3% of pay or a 2% non-elective contribution for each eligible employee.

SIMPLE IRA Filing Requirements

An employer generally has no filing requirements. The annual reporting required for qualified plans (Form 5500 series) is not required for SIMPLE IRA plans. The financial institution that holds the SIMPLE IRAs for the plan handles most of the other paperwork.

SIMPLE IRA Withdrawals:

Permitted, but withdrawals are included in income and are subject to a 10% additional tax if the participant is under age 59-1/2. Also, if withdrawals are made within the first two years of participation, the 10% additional tax is increased to 25%.

SIMPLE IRA Pros and Cons

SIMPLE IRA Pros and Cons

Pros:

1. Easy to set up and run – usually just a phone call to a financial institution gets things started.

2. Administrative costs are low.

3. Employees can contribute, on a tax-deferred basis, through convenient payroll deductions.

4. You can choose either to match the employee contributions of those who decide to participate or to contribute a fixed percentage of all eligible employees’ pay.

Cons:

1. Employers MUST contribute to the plan regardless of whether and employee contributes or not.

2. Contributions are not flexible.

3. Contribution limits are lower than other retirement plans.

Overall this plan is really more of a benefit to the employee than the employer, or small business owner. Though it is a nice incentive to maintain employees, it is fairly skewed into the employee’s favor. This plan is something I would typically use if you have some employees that are with you for many years. People you just want to reward for their service and dedication to your business since you are required to contribute every year regardless.

If you are considering a SIMPLE IRA, the IRS has put together a nice little SIMPLE IRA Checklist that will help you in determining if the play is right for you.

Banking and financing is a complicated web of information thriving in numbers and figures. While there are many online tools that makes it less of a hassle to deal with, such as Fool.co.uk Mortgage Calculator, it’s still a must to have a good background knowledge on its foundations and base concepts. That’s what our pages are all about, like the topic we’re about to discuss below.

Since I have already written the small business retirement plans quick list it is now time to break down each retirement plan that I listed before in more depth. The first that we will cover is called the Simplified Employee Pension Plan (SEP). Most of the information involves using it as an employer, but I have included the exceptions and differences in rules if you plan to use the SEP IRA as self-employed persons, partnerships, sole proprietors, independent contractors, and owner-employees of an unincorporated trade or business; however, it may be set up by any type of business.

What is a SEP?

The Simplified Employee Pension Plan, or SEP IRA as it is more commonly known, is one of the many options for funding a retirement account for your employees of any business, or just for yourself if you are self-employed. The SEP IRA is very easy to understand and the administration costs are very low, unlike other plans such as the most widely known retirement plan , the 401k. The costs are almost non-existent if you are self-employed and have no employees. Contributions are made directly to an Individual Retirement Account or Annuity (IRA) set up for each employee by the employer. No employee contributions are allowed.

Standard withdrawal rules for qualified retirement plans apply. Withdrawals before the age of 59.5 are subject to penalty, and withdrawals are taxable upon taking the money out. Money in the plan is able to grow tax-deferred while it is in the plan like any other IRA.

Setting Up a SEP IRA

The process of setting up a SEP IRA is a short and painless process. An employer must set up a SEP IRA agreement and have eligible employees. There are three basic steps according to the IRS that must be satisfied in order to create a Simplified Employee Pension Plan:

1. A formal written agreement must be executed. This written agreement may be satisfied by adopting an Internal Revenue Service (IRS) model SEP using Form 5305-SEP, Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement. A prototype SEP that was approved by the IRS may also be used. Approved prototype SEPs are offered by banks, insurance companies, and other qualified financial institutions. Finally, an individually designed SEP may be adopted.

2. Each eligible employee must be given certain information about the SEP. If the SEP was established using the Form 5305-SEP, the information must include a copy of the Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions. If a prototype SEP or individually designed SEP was used, similar information must be provided.

3. A SEP-IRA must be set up for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. The SEP-IRA is owned and controlled by the employee and the employer sends the SEP contributions to the financial institution where the SEP-IRA is maintained.

Employee Eligibility for a SEP IRA

To be eligible for a SEP IRA as an employee the following conditions must be met:

1. The employee is at least 21 years of age.

2. has worked for the employer in at least 3 of the last 5 years

3. has received at least $450 (subject to annual cost-of-living adjustments) in compensation from the employer for the year ($500 for 2007).

Employees may be excluded from the plan under only 2 conditions: (a) employees covered by a union agreement whose retirement benefits were bargained for in good faith by the employees’ union and the employer; and (b) nonresident alien employees who have no U.S. source compensation from the employer may be excluded.

SEP IRA Contribution Limits

Annual contributions an employer can make for an employee in a given year may not exceed the lesser of the following:

1. 25% of an employee’s income

2. $44,000 for 2006 ($45,000 for 2007 and subject to annual cost-of-living adjustments for later years).

The limits apply in the aggregate to contributions an employer makes for its employees to all defined contribution plans, which includes SEPs. Only up to $220,000 in 2006 ($225,000 in 2007 and subject to annual cost-of-living adjustments for later years) of an employee’s compensation may be considered. Contributions must be made in cash. Property cannot be contributed.

Regardless of the limits, an employer can choose any percentage, or total below the amount stated as the maximum allowable by the IRS. Employers are NOT required to contribute to the employees’ SEP IRAs every year. It is at the full discretion of the employer, but when contributions are made, they must be made into the SEP IRA accounts of every eligible employee.

Deducting SEP IRA contributions

Of course when contributing to an employee retirement plan an employer has the right to deduct some, or all of that contribution from the business’s taxes. Let’s look at exactly how much you can deduct for your SEP IRA contributions.

The most that may be deducted on the business’s tax return for contributions to its employees’ SEP-IRAs is the lesser of its contributions or 25% of compensation. (Compensation considered for each employee is limited to $220,000 in 2006, $225,000 for 2007 and subject to annual cost-of-living adjustments for later years.)

If the employee is self-employed and contributes to his or her own SEP-IRA, a special computation to figure out the maximum deduction for these contributions must be made. When figuring the deduction for contributions made to a self-employed individual’s SEP-IRA, compensation is net earnings from self-employment which takes into account the following deductions:

1. the deduction for one-half of the individual’s self-employment tax, and

2. the deduction for contributions to the individual’s own SEP-IRA.

See Publication 560 for details on determining the deduction.

SEP IRA for Self-Employed Individual

Self-employed individuals are subject to the same contribution limits as they would be for the sontributions they made for employees. 25%, or $45,000, whichever is less. Although the plan is very easy to use, there may be better options than using a SEP IRA if you have a significantly higher income and would like to contribute more to a retirement plan. Especially if you are married. In a leter post I will discuss the option of using the Solo 401K plan, or the Individual 401k plan as an option for sole proprietorships, partnerships, LLCs and corporations (including both subchapter S and C corporations) who have no employees.

SEP IRA Pros and Cons

Pros:

Contributions do not have to be made every year, which is very appealing. Contributions are not set at any level, and do not have to be the same every year. Very easy and cheap to set up and administer. Immediate vesting for the employee (which is an employer con). Employees must have worked for you for 3 out of the last 5 years to be eligible for contributions. If you have a high employee turnover rate, or you have a few employees that are important to your business this can be a plan that sort of disqualifies short-term employees, but at the same time rewards your loyal ones.

Cons:

Must cover all qualifying employees. Employees cannot contribute. Vesting is immediate. This means that once you put the money in it is theirs.

One of the best strategies I would use with clients that had pension plans was to have them supplement it with life insurance. There is a very good reason for this for the people that are looking to retire, and are married. Many times when someone retires and wants to start collecting on their pension plans they worked so hard for all their lives they take a reduced benefit so that if they die they will be able to leave their spouse a benefit as well. This is a nice thought, but isn’t there a better way to utilize a pension plan and have more money while you are alive? Yes. Yes there is.

Let’s consider a typical situation of the day when you start collecting on your pension. You may elect to take the reduced benefit of say 70% so that your spouse can continue to collect 40-50% of your pension if you die before they do. Most people elect to get their distributions in this way. For some it is the correct solution, but for many they could just take a 100% distribution for themselves and supplement it with a life insurance policy.

Let’s use some remedial math to look at a situation which would make the most sense for someone collecting on a pension, and qualifies for life insurance coverage. Hypothetically, if you were to take a 100% distribution on your pension you are going to get $1000 a month. So that means if you took only a 70% distribution you would get only $700 a month, but your spouse would get $500 a month after you died until they dies. What if life insurance only cost you $100 a month to cover the need for your spouse after you died? Wouldn’t it make more sense to collect $1000 a month and pay the $100 for insurance every month than it would be to just collect $700 a month? Of course it would! You would still have $900 a month while you were alive instead of $700. Your spouse would also get a big lump sum payment after you died from the life insurance policy instead of the piddly 50% benefit ever month from your pension.

Any financial advisor worth his salt should think of using this strategy for a client that has a pension plan when they will retire. More importantly, you need to think about this a bit before you retire. There is a big difference in the monthly cost of life insurance as you get older. As some insurance agents like to say: “One year older, and closer to death.”. This just means that the risk of you dying to an insurance company is greater the older you are so the cost of the insurance is more. If you get yourself insured younger the premiums will be much lower and you may avoid the unfortunate possibility that you could become uninsurable as you age due to disease, or any other ailment that disqualifies you from coverage.

As always, planning for your retirement starts as early as possible, but when it comes to life insurance as a retirement supplement this couldn’t be more true. If you have a pension plan for when you retire ask your financial advisor about this strategy. I guarantee they will love it since it not only helps you tremendously if all the numbers fall into place, but they make a good sum of money selling life insurance to you so it is a win-win for everyone.

Having a small business and wanting to offer some sort of employee incentive to keep them is always something to consider. Many small business owners are looking to add a retirement plan to their benefits package, but which one? There are several options, and it isn’t always easy to decide which small business retirement plan will work best for your particular business. Many of the financial advisors that try to sell these retirement plans to business owners aren’t really on the level as to which plan is best for YOU, but more into what will make them the most money. Often times they don’t even know what other plans are out there!

In this article I want to give you a bit of an early look on what small business retirement plans are out there and help give you a bit of knowledge on the subject before you just go with whatever plan is presented to you. I will go in depth on each plan in further posts, and will link each of them here so you will have easy access. Here I just want to point out the basic plan parameters since each plan has much more information than this post can hold.

As a business owner myself, I know that there are plenty of other business owners that don’t want to appear as if they are clueless about anything. Don’t be that guy. Ask questions, do some research, and don’t pretend to know about things that are outside of your knowledge base.

Small Business Retirement Plans Quick List

Simplified Employee Pension Plan (SEP IRA)

Elligibility: Any business.

Contribution Limits: 25% of compensation (if you’re an employee of your own corporation) up to $45,000; 20% of self-employment income (if self-employed) up to $45,000. Employees cannot contribute. But the employer must contribute to eligible employee accounts the same salary percentage they contribute to their own.

Vesting: Immediate.

Pros: Contributions do not have to be made every year. Very easy and cheap to set up and administer. Immediate vesting for the employee.

Cons: Must cover all qualifying employees. Employees cannot contribute. Vesting is immediate.

Savings Incentive Match Plan for Employees (SIMPLE IRA)

Elligibility: Employers with 100 employees or less who do not maintain any other retirement plan. All employees who have ever earned more than $5,000 in any two years prior and who will earn at least $5,000 this year.

Contribution Limits: 3% employer match (in certain situations, the match can be 1% to 2%) or 2% non-elective contribution for all employees up to $4,500 per employee. Employees can contribute up to $10,500 plus employer match up to 3%. (Employer can contribute $10,000 plus match to their own account.) Additional $2,500 if you are age 50 or older as of 12/31/07.

Vesting: Immediate.

Pros: If you have lower salary (or self-employment income), you can make larger contributions than under other types of plans. Employees can contribute.

Cons: Employer most likely cannot contribute as much as she can to a SEP IRA. Match is mandatory. Vesting is immediate. Unless the employee has a high income that would allow them to contribute more in another type of plan, they have no real cons in this type of plan.

Profit Sharing Plans

Elligibility: Any business. Employees who worked at least 1,000 hours in past year; two years, if no vesting period.

Contribution Limits: 25% of salary (20% of self-employment income) up to $45,000. No employee contributions.

Vesting: Determined by business owner.

Pros: Contributions can vary from year to year.

Cons: Administration fees may be expensive. Plan typically will need to be managed by a pro. No employee contributions.

401(k)

Elligibility: Any business. Employees who worked at least 1,000 hours in the past year; two years, if no vesting period.

Contribution Limits: Combined employer and employee’s contribution cannot exceed $45,000 ($50,000 if you are 50 or older). Employee contributions of $15,500 ($20,500 if you will be age 50 or older as of 12/31/07.)

Vesting: Determined by business owner.

Pros: Employee/employer contributions. Employers are not required to match contributions. Employees will be able to contribute, and will typically have some say as to what they will be invested in.

Cons: This plan can be quite expensive for smaller businesses due to administration fees. Employees may have a vesting period for the employee contributions.

Defined Benefit Plan

Elligibility: Any business owner or self-employed individual can create this plan. Employees who worked at least 1,000 hours in the past year; two years, if no vesting period.

Contribution Limits: No set limit. Contributions are based on actuarial assumption. Maximum annual retirement benefit is $180,000 or 100% of the participant’s average compensation for his highest three consecutive earning years.

Vesting: Determined by the business owner.

Pros: Older employers looking to put away a lot of money over short time period can do so. This can be a major benefit if you have reinvested all your profits back into the business to build it. When you have put yourself in a position to have extra money to save for yourself this plan can help you save a very large amount of money in a short time. Employees will be guaranteed a set payout upon retirement.

Cons: Not much flexibility. The plan could be very expensive as well depending on how it is set up. No employee control over investment options. No employee contributions. Vesting takes years in most plans.

What is a Stretch IRA?

A Stretch IRA is a way to take an IRA and stretch the deferred earnings over the course of many years. Many times it is used to “stretch” that term over the course of generations. When the original owner of an IRA dies, and they have established a stretch IRA, the beneficiaries are allowed to keep that money in the IRA instead of having to take a lump sum right away and pay all the taxes up front. The beneficiaries will have to take required distributions that are defined by the plan so beneficiaries of such a plan should be informed prior to receiving the IRA from an estate so they can be prepared.

Do you need a Stretch IRA?

Before you decide to get a Stretch IRA you need to take into account your goals and decide if it is the right option for you. Most people that would use this type of IRA are those that are going to have more money than they can spend while they are alive. If there are no plans in place, the beneficiary would have a major tax payment due when they inherit a traditional IRA in the year they receive it. They would get a lump sum payment and is would be part of their income! A Stretch IRA allows your beneficiaries to spread that tax burden over a course of years so that the tax hit is minimized. This also allows the money to keep accumulating tax free while it is still in the plan. As always, you will want to discuss the situation with your financial adviser so that you have looked into all the possible options for your personal situation.

Setting up a Stretch IRA

1. Review your personal situation. You must make sure that you have all your bases covered before committing to such a plan. Make sure that your insurance for a long-term health stay is in place, any possible medical expenses would be taken care of, and that any emergency is looked at and reviewed just in case.

2. You must first look at your beneficiaries and what their needs may be. It may actually be more beneficial to them that you give them the lump sum payment as you want to help them pay off a large debt that they wouldn’t be able to do if they were forced to stretch that payment over a number of years. Though it may make sense to lower the current tax burden for your beneficiaries, it may not be in their best interest to do so due to them having a need for the money right away. Many of those that want to leave money after their death do not discuss their intentions with the beneficiaries. In some cases this may be important as you don’t want them to know, don’t want to deal with family squabbles while alive, or it just isn’t all that important. If your beneficiaries are more level-headed and you want them to get the best benefit possible, it should be a priority to discuss your intentions with them while you are still alive.

3. Talk to your financial advisor. Your advisor will need to put together the appropriate documents should the two of you decide this is your best option. Your advisor just may be able to recommend a better solution as well, or at the very least be able to set this up the best way possible. If you have several beneficiaries you may need to set up more than one account for them so that you can mark what percentage each is entitled to.

Possible Negatives for a Stretch IRA

1. If you think you may actually need this money during your life there is no benefit to a Stretch IRA. As I mentioned int he last section, it is very important to review your own situation before committing to any such plan.

2. Tax law changes. It is important to understand that tax laws change over the course of our lives. Although most situations are correctable when a law changes this is something to consider.

3. This point is so important that I will mention it again. If you think there is going to be any need during your life-time for this money then you do not want a Stretch IRA.

Financial planning is a systematic approach whereby the financial planner helps the customer to maximize his existing financial resources by utilizing financial tools to achieve his financial goals.

Financial planning is simple mathematics. There are 3 major components :

* Financial Resources (FR)
* Financial Tools (FT)
* Financial Goals (FG)

When you want to maximize your existing financial resources by using various financial tools to achieve your financial goals, that is financial planning.

Financial Planning : FR + FT = FG

In other words, financial planning is the process of meeting your life goals through proper management of your finances. Life goals can include buying a home, saving for your children’s education or planning for retirement. It is a process that consists of specific steps that help you to take a big-picture look at where you are financially. Using these steps you can work out where you are now, what you may need in the future and what you must do to reach your goals.

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