By George M. Hiller, JD, LLM, MBA, CFP®
New tax law has greatly expanded the contribution limits for certain types of retirement plans often used by the self-employed and small business owner. A SEP (simplified employee pension plan) is somewhat like an IRA (with much larger contribution limits).
For 2003 as much as $40,000 can be contributed to a SEP account depending upon amount of net earnings and other adjustments. The general contribution limitation for 2003 is 25% of net earnings.
The time limit for setting up and funding a SEP plan is the filing deadline for your income tax return including extensions. Thus, you may establish and fund a SEP account as late as October 15, 2003 (the last expiration period of the last allowable extension) and still get a tax deduction for the tax year 2002.
For self-employed individuals certain adjustments end up reducing the percentage limitation from 25% of net earnings to 20% of net earnings. Even with the required adjustments the amount that can be contributed to a SEP account is substantially increased.
Another type of retirement plan is the SIMPLE IRA. The SIMPLE IRA is for businesses that have no other type of retirement plan and have less than 100 employees. Employees can elect to have a part of their salary go pre-tax to fund a SIMPLE IRA account. The salary deferral going into the SIMPLE IRA is not subject to federal or state tax withholding, but is subject to social security and Medicare taxes. The employer must choose either to match up to 3% of employee compensation on a dollar for dollar basis or commit to a minimum contribution of 2% of every eligible employee’s compensation.
For 2003 employees can elect to have up to $8,000 of their compensation funded to a SIMPLE IRA account pre-tax. The employer would then kick in up to 3% of compensation if using the matching formula or otherwise 2% of compensation up to $8,000 in employer contribution.