How Employee Compensation Works

Money Purchase Plans

Money-purchase plans are like profit sharing plans that require a set amount (usually a percentage of the employee's salary) be contributed by the employer each year, even in years where there is no profit. Employees can contribute up to 25% of their salaries or a maximum of $40,000 per year. On the flip side, money-purchase plans give employers the maximum tax advantage possible.


If you have 100 or fewer employees and offer no other retirement pension plan, the Savings Incentive Match Plan for Employees (SIMPLE) IRA provides a simplified way to make contributions to a retirement plan either for yourself if you're a sole proprietor, or for your employees. With this plan, your employees can make monthly contributions (salary deferrals), and you, as the employer, have the option of two types of contribution methods. You can either match the first 3% of the employee's contribution dollar for dollar, which by the way does help encourage participation by your employees, or you can opt to make a non-elective contribution equal to 2% of your employees' pay. If you choose to match your employees' contributions, you do have the option of altering the amount to fall somewhere between 1% and 3% for two out of every five years.

Your employees can contribute up to $8,000 in 2003, and no other contributions -- other than your employer match or non-elective contributions -- can be made. If the employee is less than 59 1/2 years old and hasn't contributed to the plan for at least two years, then withdrawn funds may face a 25% penalty tax.

The SIMPLE IRA has lower administrative costs than other plans. The plan is simple with regard to reporting requirements, and it isn't subject to nondiscrimination and top-heavy rules that limit the benefits provided to your highest paid employees. Your contributions are tax deductible. Your employees will be immediately 100% vested. They can set up their investment portfolios to suit their own goals and situations. They can also roll the account over to another SIMPLE IRA account with no tax penalty.

SIMPLE 401(k)

The SIMPLE 401(k) plan has many of the same requirements and features as the SIMPLE IRA, but it allows your employees to contribute a pre-tax portion of their salary. This plan will give your company a leg up in more competitive job markets. As with the SIMPLE IRA, you must have fewer than 100 employees and offer no other employer-sponsored retirement plan. Your contributions are tax deductible for your business, and you can contribute up to 15% of your eligible employees' salaries. Employees can invest up to $8,000 in 2003, can tailor their own investments, can borrow from their accounts, and earnings are tax-deferred until they are withdrawn.

Simplified Employee Pension (SEP) Plan

An SEP plan is basically individual IRAs set up for all of your employees that aren't subject to the $2,000 per year IRA limit. As an employer, you can contribute up to 25% tax deferred of your employees' annual salaries (up to $40,000), and can set the plan up at any time during the year. Your employees can control how their accounts are invested, and are full-owners (there is no vesting period) from the very beginning. Your employees do, however, have to be at least 21 years old, and have to have worked for your company for at least three of the past five years.

There are several benefits of an SEP plan. They are simple to set up and administer, and you have no government filings to maintain because the employees are responsible for their own accounts. You can change your contributions at any time, and the contributions are still tax-deductible for your business. To set one up, you have to implement a written agreement to provide benefits to your eligible employees, give the eligible employees information about the SEP and have them set up SEP-IRA accounts (or you can set up the accounts for them).

Aside from these most common benefits discussed so far, there are many other forms of benefits you can offer your employees.