BY KENNETH A. HOROWITZ
A Simplified Employee Pension Individual Retirement Arrangement (SEP-IRA) or a Profit Sharing Plan (PSP): Which plan is right for your client or business?
Last week compared several differences between the profit sharing and SEP plans. Part 2 hews again to the SEP vs. PSP differences and what they mean for clients and for businesses in the arenas of design, employee exclusion, loans, last-day requirement and vesting.
Individual Design
SEPs do allow for integration, however, contributions are typically defined on a pro rata basis, meaning a uniform percentage of pay formula for all participants. For example, if contribution owner A is 25 percent of pay, contributions for other plan participants would also be 25 percent of pay ”” that can be costly.
However, a PSP structure allows for use of different percentages of pay rates as long as nondiscrimination testing 401(a) (4) is satisfied. One example is using new comparability to create different rate groups providing there are established reasonable job classifications. Here”™s an example of how a business owner with employees can find it more advantageous to establish a Profit Sharing Plan/401(k) rather than a SEP. By adding the deferrals and catch-up contributions to a new comparability PSP, the business owner increases his maximum tax-deductible contribution by 118 percent, as illustrated below.
Part-time & Seasonable Employee Exclusion
The eligibility rules are more liberal under SEPs. Both plans require minimum age of 21. However, required years service for SEPs can be as satisfied by working an hour, three of the prior five years, and earning a minimum annual salary of $550. This can allow many people to be included in a retirement plan that would otherwise not be the case under a profit sharing situation.
Additionally, employees have immediate investing on 100 percent of employer contributions.
PSP structure on the other hand, may require a minimum 1,000 hours annually of service and one year of employment for eligibility. Employees are then vested on either a 3-year cliff or a 6-year graded gradual scale of 20 percent a year for five years of employer contributions. The nonvested amounts get refunded back to the plan and either allocated among participants based on the allocation formula under the plan, or they may be used to reduce future costs of the plan.
Last Day Requirement
An employee may be required to be employed by the company for the last day of the year to be eligible for a contribution in a PSP, subject to nondiscrimination testing.
401(a)(4) Loans
As an IRA, SEPs do not allow for loans. Loans may be permitted under PSP plans.
Vesting
All employer contributions to employee accounts in SEPs have immediate vesting. An employee for example gets 100 percent of the employer contribution when they leave. That can be much more costly to an owner compared with vesting in a PSP. Where here is a 6-year vesting schedule ”” 20 percent after year two and 20 percent for the next four years. No doubt the vesting schedule will encourage employees to stay with the company. Additionally, an employee will forfeit part of the contributions should they leave before six years. As mentioned earlier, they may be required to be employed the last day of the year to eligible for a contribution. In a SEP, an employee can qualify for and vest for the full contribution as soon as they satisfy the nominal income and hourly guidelines.
Kenneth A. Horowitz is a registered representative and financial adviser of Park Avenue Securities L.L.C., doing business in Rye Brook, N.Y., as Integrated Benefit Consultants. He can be reached at (914) 288-8946.
