Many small business owners would do much better by using a Safe Harbor Cross Tested 401(k) Plan instead of a SIMPLE or SEP. For example, suppose the business owner of a corporation takes $260,000 in compensation and wants the maximum contribution of $52,000 in an SEP. That would be a 20% of compensation contribution. In an SEP, if you want to put away 20% for the owner, you generally have to contribute 20% of salary for each eligible employee. If you had just two employees making $50,000 each, that would be $10,000 each or $20,000 total in contributions for them.
Alternatively, with a Safe Harbor Cross Tested 401(k), it might be possible to contribute 5% of pay or less for the support staff while still maxing out for the owner at $52,000. The Cross Tested 401(k) will even be more effective than an SEP for a business owner or partnership with modest self-employment income.
The SEP is an okay solution for many companies but the Safe Harbor Cross Tested 401(k) might be a far better solution for many others. Even with only one or two support employees, the savings could be thousands of dollars. In our example, if the contribution was 5% for each employee, the total would be $5,000. This would be $15,000 in savings. Yes, you would have to pay to administer the 401(k) plan, but if that was $2,000 a year, the business owner would still have $13,000 per year in savings. For the concept to work, we need about half of the employees to be somewhat younger than the business owner.
As a CPA, you may want to identify all of your clients using an SEP, particularly if they have eligible employees, and encourage then to contact us for a free illustration of how a Safe Harbor Cross Tested 401(k) Plan might be far more effective - perhaps saving them a lot in the contributions for staff category.
All we need is a simple census of name, date of hire, date of birth and compensation estimate for their staff and some indication of their expected Schedule C, K-1 or corporate compensation. If deductions beyond $57,500 are desired, then we can show the your client how a Cash Balance 401(k) Combo might work. Depending upon the business owner's age, deductions of $200,000 or more may be possible.
