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Change from a SEP or SIMPLE to a 401(k) Profit Sharing Plan: Evolution from the SEP to a 401(k) plan

Written on August 15, 2018

No better time than the present to evaluate changing from a SEP or SIMPLE to a 401k Profit Sharing Plan.

SEP plans were originally established as an alternative to the complex rules of ERISA. SEPs and SIMPLEs are often utilized by smaller companies because of the simplicity of operations. The contributions for these plans are tax deductible with no annual testing or annual filings. However, the trade-off to the reduced administration and reporting requirements is much less flexible.

Any employee who is over 21, has worked for your business in at least three of the last five years and has received at least $600 in compensation for the year (2018) is eligible to participate in a SEP or Simple plan. An employer does have the ability to change the contribution from year to year. However, the amount is the same proportionate percentage across all eligible employees’ compensations. If the owner wishes to contribute 25 percent of his compensation to his account, then he must contribute 25 percent to all eligible employees’ accounts.

As a business grows, the company’s group of eligible employees becomes larger, and the owner’s ability to maximize his or her contribution under the plan becomes less likely.

Qualified plans, such as a profit sharing plan, 401(k) plan or combination of the two, allow for more flexibility in the design and funding of the plan. With this additional flexibility comes additional testing regulations and administration. However, the potential benefits that these plans provide to the company and its employees could far outweigh the additional costs and responsibilities.

What if you could decrease overall cost and increase the benefit to the owners?

A husband and wife had an SEP to which they were contributing 25 percent of annual pay. Switching to a New Comparability 401(k) plan allowed them to get $61,000 and $34,500 respectively—a total of $45,500 more than under the SEP. The 401(k) Plan only required a total employer contribution of 5 percent to all eligible employees. This amounts to a savings of $103,554 compared to the SEP. You can see the comparison here.

Along with these savings, the employer has the added flexibility of excluding employees who work less than 1,000 hours. In addition, a vesting schedule of up to six years can be used.

It is not too late to set up a 401(k) plan in 2018. If you are currently utilizing a SEP and have not contributed for 2018, you can still set up a 401(k) plan.

If you are looking to maximize the contributions to a select group of participants while keeping your overall contribution cost to a minimum, a New Comparability 401(k) plan might be right for you!

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