Simplified Employee Pension Plans (SEP), are an attractive way for self-employed individuals to put away large sums of money into a retirement plan. A SEP Plan provides employers with a simplified method to make contributions toward their employees’ retirement, and if self-employed, their own retirement. A SEP is established by an employer adopting a SEP agreement, and having employees establish a SEP IRA.
There are three basic steps to setting up a SEP, all of which MUST be satisfied.
First of all, an employer must establish and properly execute a formal written agreement. The IRS makes this simple by having its own model SEP plan on Form 5305-SEP. Secondly, each eligible employee must be given certain information about the SEP plan. A SEP-IRA must be set up for each eligible employee.
An eligible employee is an employee that meets the following criteria:
• Is at least 21years of age AND
• Has performed service for the employer in at least 3 of the last 5 years
An eligible employee must participate in the plan, including part-time and seasonal employees.
The term “employee” is not only someone that works for you; it is you if you receive compensation from the business. Generally, compensation is any amount that you pay yourself in salary or your employees. If a sole-proprietorship or partner it is the amount that is exposed to Self-Employment tax.
Once the plan is adopted, it is very simple and easy to operate. Your trustee (brokerage firm) will take care of depositing the contributions, investments, annual statements and they will take care of the yearly filings that have to be done with the Internal Revenue Service. Your obligation is to forward contributions from yourself and your employees to the trustee by the date that they are due.
Your obligation is to forward contributions from yourself and your employees to the trustee by the date that they are due. You can establish a SEP IRA up to the due date of the tax return, for which you want the contributions to be deductible. For individuals and partnerships this would be April 15th. For S-Corporations and calendar year Corporations this would be March 15th. For fiscal year Corporations it would be the 15th day of the third month of the month that the fiscal year ended.
For a SEP, the contribution limit is 25% of compensation for any given tax year. The maximum, contribution is $51,000.00 for 2013. The amount of the contribution is tax deductible, and the contributions grow tax free. Unlike a 401(k) or a SIMPLE Plan, the plan does not allow for employee salary deferrals.
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Unlike a 401(k) that has to follow vesting rules, a SEP IRA is vested the minute the contribution is made. What that means is a participant in the plan can make distributions to themselves whenever they want. Of course these distributions are taxable and may be subject to an early distribution penalty, but they can be made.
A major advantage to a SEP is that it is the easiest plan, by far, to set up and maintain. The SEP IRA plan eliminates:
1. The administrative complexity found in many retirement plans
2. Lengthy and detailed government reporting
3. Numerous nondiscrimination tests
4. Complicated, restrictive contribution formulas associated with many retirement plans
The flexibility of contributions to a SEP IRA, also make it easier than other plans. The employer is not required to make contributions on an annual basis. However, when the contributions are made, they have to be made by the same percentage for all employees. Another benefit is that if you have earned income, after 70 ½ you are still allowed to contribute.
Like any retirement plan, there are drawbacks. The Internal Revenue Service monitors and restricts all IRA plans regardless of type because of the tax implications of them. However the real disadvantage to the SEP is that it is limited to the contributions of the employer of the employee’s earnings. The employee cannot make contributions to the plan. All contributions must be made by the employer and based on the employee’s earnings. Because of this, the plan takes away a bit of control. For instance, if the employer selects a contribution limit of 25% of compensation for himself, he must make a 25% contribution to his employee’s account as well. If the employer has multiple employees, this can be a substantial expense to the employer.
A disadvantage to the employee is that, unlike traditional 401(k) plans established by larger corporations, employees are unable to contribute to their own retirement account. Another consideration is that employees who would otherwise elect pay raises or other bonuses are now forced into a savings program that they may not want.
Not being able to contribute to the plan means that the employees are not allowed to put pre-tax monies into a retirement account limiting what they can save for retirement. Further, unlike some 401(k) plans, SEP Plans do not allow for loans against the balance of the account. If a distribution is made, unless it is a rollover, is taxable to the employee.
SEP IRAs are a nice way for employers and employees to put away money for retirement, and make have large tax deductions at the same time.
For more information visit www.smalleynco.com
If you have any questions you can email Craig W. Smalley E.A.
Author of the books: It Starts With an Idea – Tax Tips for Small Businesses available on Nook and Kindle, The Ultimate Real Estate Investor Tax Guide, available on Nook and Kindle, The Complete Guide to the New Tax Law – American Taxpayer Relief Act of 2012 available on Nook and Kindle, Everything You Wanted to Know about the IRS – Audits, Appeals and Collections available on Nook and Kindle, and Tax Avoidance is Legal! The Complete Guide to Individual Income Tax available on Nook and Kindle
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