Robert D. House, Certified IRA Specialist

Simplified Employee Pension (SEP) IRA Plans

The First Step is taking Stock...

The simplified employee pension plan (SEP) is an IRA based employer sponsored retirement plan that SEP can be established by any business entity, including sole proprietorships, partnerships, and corporations. The features and benefits of a SEP IRA are the factors that determine whether an employer chooses the SEP over other retirement plans, such as a SIMPLE IRA or a qualified plan.

Establishing your SEP IRA

Establishing your SEP IRA can be as easy as completing the IRS model Form 5305-SEP. However, most financial institutions require that you complete their SEP forms. For a simple, no frills SEP IRA, either the IRS Model 5305-SEP form or the financials institution’s version of their 5305-SEP form is used. However, if you need a SEP with special provisions, such as contributions under a social security integration formula, you want to maintain the SEP on a fiscal year instead of a calendar year, or you want to maintain the SEP along with a qualified plan, you must use an individually designed SEP agreement or the financial institution’s prototype SEP agreement.

Benefits of establishing a SEP for your business

Similar to qualified plans, the SEP IRA provides retirement benefits for you as the business owner, as well as your employees who are eligible to participate in the plan. Your business receives a tax deduction for contributions to the plan, and employees get the benefit of tax-deferred growth on the amounts you contribute to their accounts. Additionally, having a SEP IRA can serve to attract and retain high quality employees, and unlike qualified plans, the administration for SEP IRAs is simple and inexpensive.

Employee eligibility

If you establish a SEP IRA for your business, you may allow all of your employees to participate in the SEP IRA. Alternatively, you may choose to allow only employees who meet certain requirements to participate in the plan.  Should you decide to limit participation only to certain employees, bear the following limitations in mind, as these are the strictest requirements you are allowed to choose for the plan.

• Age limitation- You can exclude your employees who have not reached age 21
• Service limitation - You can exclude your employees who have not performed services for your business for at least three of the five preceding years
• Compensation limitation - You can exclude your employees who earned less than $500 for the year
• You can also exclude nonresident aliens with no income from the United States and unionized employees.

 

When choosing the limitations on eligibility, ensure that you are not also excluded from participating in the plan. For instance if you are under age 21, you would not want to exclude employees under age a 21, as you would also be excluded.

SEP Contributions

Contributions to your SEP plan should not exceed 25 percent of eligible compensation. In addition, no employee should receive contributions in excess of $45,000 (for 2007). Finally, the maximum compensation for any employee that can be taken into consideration for SEP purposes is $225,000 These limitations are explained in the following examples, which assume you have elected to contribute 20 percent of compensation to each employee’s SEP IRA.
 

Example 1:

John earns $250,000. John will receive a SEP contribution of $45,000.
The $45,000 limit applies because:

• The maximum compensation that can be considered is $225,000, and
• 25 percent of $225,000 is $45,000

Example 2
Tim earns $50,000. Tim will receive $10,000, which is 20% of his compensation.

The allocation formula used in this example is the pro-rata formula, where each employee receives the same percentage of contribution. You have the option of using other formulas, such as a flat dollar formula, where each employee receives the same dollar amount, or a social security integration formula where employees who earn over certain amounts receive a higher percentage of the contributions than other employees. Flat dollar and social security integration formulas require the use of a customized or prototype SEP document. Additionally, contributions made under a social security integration formula are complex and usually requires the assistance of a plan administrator or tax attorney to compute the amounts.
Contribution Flexibility

SEP contributions are discretionary. This means that you are not required to contribute to the plan each year. This is an attractive feature for new business that have not yet determined a profit pattern, or for business with cyclical profit history.

Deadlines

SEP contributions must be deposited to employees SEP IRAs by the tax-filing deadline of your business, including any extensions.

Your SEP IRA plan must also be established by the tax-filing deadline of your business, including any extensions.

Distributions Rules

Once assets are deposited to a SEP IRA, they are treated as regular Traditional IRA assets and are subject to the Traditional IRA distributions rules. See our Traditional IRA overview for an explanation of the distributions rules.

Conclusion

The suitability of the SEP IRA for your business depends on factors which includes your business profile, the turnover rate of your staff, and the age of your staff.
Contact us for assistance with determining if the SEP IRA is right for your business, as well as for assistance with determining the administrative requirements that must be met in order to remain in compliance with regulatory requirements.

 

 

Robert House