Individual retirement accounts (IRAs) are a popular way of taking a tax deduction. Many employers offer matching contributions to retirement accounts as a benefit to employees in order to recruit and retain top talent. An IRA can also be a particularly beneficial way of reducing business tax liability, as long as the deduction follows all tax requirements. The IRS has strict rules about IRAs, including contributions and how much can be deducted within annual contribution limits that also account for employer contributions.
Can an Employer Contribute to an IRA for an Employee?
Employer-sponsored retirement plans can vary from employer to employer. Many employers offer retirement contributions such as matching for employees. While this may be more readily associated with 401(k) accounts, employers can also contribute to IRA accounts. Depending on the type of retirement account, an employer may or may not be able to match funds for retirement benefits with any associated tax deductions.
Employers can deduct contributions made to eligible employee IRAs if they are made by the tax year due date. IRAs are a good way to reduce business tax liability while helping employees and self-employed business owners save for retirement. There are also cost of living adjustments that are required each year for employer-funded retirement accounts.
Which IRA Accounts Are Eligible for Employer Contributions?
There are four basic types of IRA-based accounts – payroll deduction IRAs, Simplified Employment Plan (SEP), Salary Reduction Simplified Employee Pension Plan (SARSEP) and the Savings Incentive Match Plan for Employees (SIMPLE). Forbes states there are pros and cons to payroll deduction IRAs versus other IRA types.
Payroll deduction IRAs consist of traditional and Roth IRAs, which are funded through deductions directly from an employee's payroll wages. These IRA accounts are funded solely by the employee without contribution from the employer, (there is also no tax benefit for the employer to contribute to these accounts). Alternately, SEP, SIMPLE and SARSEP accounts can be funded with employer contributions. Each category of account is subject to requirements specific to the account type per the IRS.
Keep in mind that there are several rules regarding employer contributions depending on the IRA type – such as eligibility, nondiscrimination and top-heavy testing. For example, in a SEP or SARSEP plan, when 60 percent or more of the plan's assets are attributed to highly compensated or key employees, it is a situation known as "top-heavy." In these instances, employers must perform a correction by contributing to the accounts of other employees.
Tax Deductible Employer IRA Contributions
The SEP plan is designed for small businesses and self-employment; it is entirely funded by the employer. In a SEP IRA, employers can contribute a maximum of 25 percent up to $290,000 of an employee's compensation for a maximum contribution of $58,000 in 2021. Employers must also contribute proportionally to every eligible employee.
The maximum tax deduction for employers is the lesser of an employer's contributions totaling not more than 25 percent of the employee's compensation. Going over the contribution limit can result in excise taxes. Employer contributions are not taxed as gross income for employees.
SARSEP accounts were designed for small businesses before the 401(k) became widespread. They are funded either through elective employee contributions or non-elective employer contributions. SARSEP accounts were disallowed as an IRA option in 1997, so any current SARSEPs are grandfathered plans. Both employees and employers may make contributions to a SARSEP.
SIMPLE accounts enable employees at small companies (with less than 100 employees) the opportunity to save for retirement in a way that is simpler than a 401(k). It is selected as a start-up plan because the costs and complexity of managing SIMPLE accounts are minimal compared to other retirement plans. There are a few rules for contributions. Employees can contribute pre-tax dollars up to $13,5000 (or $16,500 for those over 50) to the SIMPLE.
Employers must choose between matching (elective) and nonelective contributions in a SIMPLE plan. The elective contributions will match employee contributions up to 3 percent, but can be reduced to 1 percent in two out of five years. Nonelective contributions mean that an employer will contribute to the IRA even if the employee does not. T
he alternative to matching contributions is for the employer to contribute 2 percent of an employee's compensation. There are no rules regarding nondiscrimination or top-heavy testing for the SIMPLE IRA.
Hashaw Elkins is a financial services and tax professional, as well as a project management consultant. She has led projects across multiple industries and sectors, ranging from the Fortune Global 500 to international nongovernmental organizations. Hashaw holds an MBA in Real Estate and an MSci in Project Management. She is further certified in organizational change management, diversity management, and cross-cultural mediation. <!--StartFragment--><!--EndFragment-->