What are Simplified employee pensions (SEPs)?
SEPs are intended as an alternative to “qualified” retirement plans, particularly for small businesses. The ease of administration and the complete discretion of employer are permitted in deciding whether or not to make annual contributions, are features that are especially attractive. Under a SEP, an employer contributes directly to traditional individual retirement accounts (SEP-IRAs) for all employees (including themselves). A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee’s pay.
How do Simplified employee pensions (SEPs) work?
SEPs are very easy to understand and setup. This is what makes them a great retirement plan for many small business. If you don’t already have a qualified retirement plan, you can set up a SEP simply by using the IRS model SEP, Form 5305-SEP. By adopting and implementing this model SEP, which doesn’t have to be filed with the IRS, you will have satisfied the SEP requirements. This means that you, as the employer, will get a current income tax deduction for contributions you make on behalf of your employees. Your employees will be taxed not when the contributions are made, but at a later date when distributions are made, usually at retirement.
Making Contributions to a SEP IRA
Depending on your specific needs, an individually-designed SEP-instead of the model SEP-may be appropriate for you. When you set up a SEP for yourself and your employees, you will make these deductible contributions to each employee’s IRA, called a SEP-IRA, which must be IRS-approved.
Amounts you can contribute to SEP-IRA
The maximum amount of deductible contributions that you can make to an employee’s SEP-IRA, and that he or she can exclude from income, is the lesser of:
- 25 percent of compensation, and
- $52,000 (for 2014).
The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA. Your employees control their individual IRAs and IRA investments, the earnings on which are tax-free. There are other requirements which you have to meet to be eligible to set up a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of the highly compensated employees.
Who is eligible for SEP-IRA?
Eligible Employee – An eligible employee is an employee who:
- Is at least age 21, and
- Has performed service for you in at least 3 of the last 5 years.
All eligible employees must participate in the plan, including part-time employees, seasonal employees, and employees who die or terminate employment during the year.
Who can establish a SEP IRA
A SEP may be established as late as the due date (including extensions) of the company’s income tax return for the year you want to establish the plan. For example, if your business’s fiscal year (a corporate entity) ends on December 31 and you filed for the automatic 6-month extension, the company’s tax return for the year ending December 31, 2013, would be due on September 15, 2014, allowing you to make the initial SEP contribution no later than September 15, 2014.
What record-keeping is needed for a SEP?
The detailed records that traditional plans must maintain to comply with the complex nondiscrimination regulations aren’t required for SEPs. And employers aren’t required to file annual reports with IRS-Forms 5500-which, for a pension plan, could require the services of an actuary. What record-keeping is required can be done by a trustee of the SEP-IRAs-usually a bank or mutual fund.
Another option for a business with 100 or fewer employees is a “savings incentive match plan for employees” (i.e., a “simple” plan). Under a simple plan, a “simple IRA” is established for each eligible employee, with the employer making matching contributions based on contributions elected by participating employees under a qualified salary reduction arrangement. The simple plan is subject to much less stringent requirements than traditional qualified retirement plans. Or, an employer can adopt a “simple” 401(k) plan, with similar features to a simple plan, and automatic passage of the otherwise complex nondiscrimination test for 401(k) plans.
Operation of a SEP
Once in place, a SEP is simple to operate. Your trustee will take care of depositing the contributions, investments, annual statements, and any required filings with the IRS. You will need to ensure that your plan is kept current with the law.
In addition, the following jointly developed publications are available on the DOL and IRS websites and can be ordered through the toll-free numbers listed below:
- Choosing a Retirement Solution for Your Small Business, Publication 3998, provides an overview of retirement plans available to small businesses.
- 401(k) Plans for Small Businesses, Publication 4222, provides detailed information regarding the establishment and operation of a 401(k) plan.
- Adding Automatic Enrollment to Your 401(k) Plan, Publication 4721, explains how to add automatic enrollment to your existing 401(k) plan.
- Automatic Enrollment 401(k) Plans for Small Businesses, Publication 4674, explains a type of retirement plan that allows small businesses to increase plan participation.
- Payroll Deduction IRAs for Small Businesses, Publication 4587, describes an arrangement that is an easy way for businesses to give employees an opportunity to save for retirement.
- Profit Sharing Plans for Small Businesses, Publication 4806, describes a flexible way for businesses to help employees save for retirement.
- SIMPLE IRA Plans for Small Businesses, Publication 4334, describes a type of retirement plan designed especially for small businesses.