A Simplified Employee Pension plan (or “SEP”) is a retirement plan established by a business. Though the plan was specifically designed for self-employed individuals and small business owners, almost any type of employer can establish an SEP plan. Sole proprietors, partnerships and corporations can use one. Furthermore, there is no limit to the number of employees that can participate in an SEP.
One of the advantages to an SEP is that it does not come with the high start-up and maintenance costs commonly associated with more traditional retirement plans such as money purchase pensions, profit sharing and 401(k) plans.
A few details:
1. Eligibility – Typically, any employee who is at least 21 years old, has been employed by the business at least 3 of the previous 5 years and has compensation of at least $500 for the year, is entitled to participate in an SEP plan. An employer may loosen (but not tighten) these restrictions at its discretion.
2. Plan Contributions – Under an SEP plan, an employer makes contributions to the traditional IRAs of its eligible employees. Contributions are made solely at the employer’s discretion. Every year the business owner must decide whether to make an SEP contribution for the year and, if so, how much.
3. Contribution Limits – An employer may contribute up to 25% of each eligible employee’s compensation. However, the Internal Revenue Code limits both the dollar amount that can be contributed on behalf of an employee and the amount of compensation that can be used in computing an employee’s SEP contribution. For 2013, the maximum contribution amount for a single employee is $51,000. The maximum amount of compensation that can be considered when computing an individual’s contribution is $255,000.
4. Timing Of Contributions – If a business owner elects to make an SEP contribution for a given year, the contribution must be made by the employer’s tax filing due date for that year, including extensions.
6. Vesting of Contributions – Employer contributions deposited to an employee’s IRA are immediately 100% vested.
5. Employee Contributions – Employees are not permitted to make contributions through their employer’s SEP plan.
7. Establishing an SEP – Establishing an SEP plan requires action by both the business owner and its employees.
Employer – The employer must complete an SEP plan document. The most commonly usedform for this purpose is IRS Form 5305-SEP. Alternately, an employer may use an IRS-approved prototype SEP document or an attorney-drafted, individually designed SEPdocument that has been approved by the IRS. Once the desired plan document iscompleted, the employer must give a copy of the document to each eligible employee,along with a Summary Plan Description.
Employees – Every eligible employee must either establish a new traditional IRA to receive their employer’s SEP contributions or designate one of their existing traditional IRAs for that purpose.
8. Investment Options – After the employer’s contribution has been deposited to an employee’s traditional IRA, all the standard IRA rules apply to the account. An employee’s investment options will therefore be determined by what is offered by their IRA custodian.
Be sure to consult with your tax advisor to determine whether an SEP plan is the right plan for your business. The right type of retirement plan can help your business prosper and providing such a desirable benefit will help your firm attract and retain high quality employees and allow you and your employees to build up retirement savings.