A Simplified Employee Pension (SEP) plan is a retirement savings option that allows employers to save money for themselves and their employees. With a SEP, an employer can contribute directly to traditional individual retirement accounts (SEP-IRAs) for all employees, including themselves. This can provide a significant source of income in retirement.
One of the advantages of a SEP plan is that it is relatively easy to set up and has lower operating costs than traditional retirement plans. Additionally, a SEP allows for contributions of up to 25 percent of each employee’s pay, which can be a significant amount of money over time.
SEP plans are a good option for small business owners and self-employed individuals who want to save for retirement while also providing retirement benefits to their employees. By contributing to a SEP-IRA, employees can take advantage of tax-deferred growth and potentially reduce their taxable income. Overall, a SEP plan can be a simple and cost-effective way to save for retirement.
However, SEP’s can be costly as you need to contribute the same amount for each employee as a percentage of their compensation. Instead, a profit sharing or a floor offset defined benefit plan might prove to be beneficial as it allows contributions for the owners to be significantly higher.
One of the advantages of a SEP plan is that it is relatively easy to set up and has lower operating costs than traditional retirement plans. Additionally, a SEP allows for contributions of up to 25 percent of each employee’s pay, which can be a significant amount of money over time.
SEP plans are a good option for small business owners and self-employed individuals who want to save for retirement while also providing retirement benefits to their employees. By contributing to a SEP-IRA, employees can take advantage of tax-deferred growth and potentially reduce their taxable income. Overall, a SEP plan can be a simple and cost-effective way to save for retirement.
However, SEP’s can be costly as you need to contribute the same amount for each employee as a percentage of their compensation. Instead, a profit sharing or a floor offset defined benefit plan might prove to be beneficial as it allows contributions for the owners to be significantly higher.
• Tax Deductible Contributions: Contributions made to a SEP IRA are tax-deductible, and the earnings on the investments are not subject to taxes.
• Flexibility: There is no obligation to make contributions to SEP-IRAs every year. Employers can decide whether to contribute and how much to contribute each year.
• Minimal Paperwork: Generally, no government filings are required to set up and maintain a SEP IRA plan.
• Wide Applicability: Sole proprietors, partnerships, corporations, and S corporations are all eligible to establish SEP plans.
• Tax Credits: Employers may be eligible for tax credits of up to $500 per year for the first three years to cover the cost of starting the plan.
• Low Administrative Costs: SEP plans are typically easy to set up and operate with low administrative costs.
• Flexibility: There is no obligation to make contributions to SEP-IRAs every year. Employers can decide whether to contribute and how much to contribute each year.
• Minimal Paperwork: Generally, no government filings are required to set up and maintain a SEP IRA plan.
• Wide Applicability: Sole proprietors, partnerships, corporations, and S corporations are all eligible to establish SEP plans.
• Tax Credits: Employers may be eligible for tax credits of up to $500 per year for the first three years to cover the cost of starting the plan.
• Low Administrative Costs: SEP plans are typically easy to set up and operate with low administrative costs.
An “eligible employee” is an employee who meets two requirements: they must be at least 21 years old, and they must have performed service for the employer in at least three of the last five 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. This means that the employer cannot exclude any eligible employees from participating in the SEP IRA plan.
The term “employee” also includes employees of certain other businesses owned by the employer and/or their family and certain leased employees.
For participation in a SEP IRA, an “employee” refers not only to someone who works for the employer but also includes the employer themselves if they receive compensation from the business. This means that the employer can contribute to a SEP-IRA on their own behalf.
All eligible employees must participate in the plan, including part-time employees, seasonal employees, and employees who die or terminate employment during the year. This means that the employer cannot exclude any eligible employees from participating in the SEP IRA plan.
The term “employee” also includes employees of certain other businesses owned by the employer and/or their family and certain leased employees.
For participation in a SEP IRA, an “employee” refers not only to someone who works for the employer but also includes the employer themselves if they receive compensation from the business. This means that the employer can contribute to a SEP-IRA on their own behalf.
Here is an example of a SEP IRA plan for a small business. The business owner can decide the % of contribution (up to 25% of compensation). This must be applicable to all employees.
| SEP IRA Contribution Estimation | |||
| Age | Compensation | SEP IRA Contribution | |
| HCE: | |||
| Owner | 45 | 265,000.00 | 53,000.00 |
| Subtotal | 265,000.00 | 53,000.00 | |
| NHCE: | |||
| Employee 1 | 25 | 30,225.95 | 6,045.19 |
| Employee 2 | 24 | 25,878.66 | 5,175.73 |
| Employee 3 | 25 | 13,081.04 | 2,616.21 |
| Subtotal | – | 69,185.65 | 13,837.13 |
| Total | 334,185.65 | 66,837.13 | |
For comparison, the below table shows the possible contributions if the owner implements a new comparability profit sharing plan
| New Comparability Design | |||||||
| Profit Sharing 401(k) Plan | |||||||
| Name | Age | Compensation | Profit Sharing | Safe Harbor | 401(k) | Total | % |
| HCE: | |||||||
| Owner | 45 | 265,000.00 | 27,050.00 | 7,950.00 | 18,000.00 | 53,000.00 | 91.01% |
| Subtotal | 265,000.00 | 27,050.00 | 7,950.00 | 18,000.00 | 53,000.00 | 91.01% | |
| NHCE: | |||||||
| Employee 1 | 25 | 30,225.95 | 604.52 | 906.78 | – | 1,511.30 | 3.93% |
| Employee 2 | 24 | 25,878.66 | 517.57 | 776.36 | – | 1,293.93 | 3.36% |
| Employee 3 | 25 | 13,081.04 | 261.62 | 392.43 | – | 654.05 | 1.70% |
| Subtotal | – | 69,185.65 | 1,383.71 | 2,075.57 | – | 3,459.28 | 8.99% |
| Total | 334,185.65 | 28,433.71 | 10,025.57 | 18,000.00 | 56,459.28 | 100.00% | |
Should the business owner have more cash flow, they can consider implementing a Floor Offset Defined Benefit Plan.
| Floor Offset Arrangement | ||||||||
| Defined Benefit Plan | Profit Sharing 401(k) Plan | |||||||
| Name | Age | Compensation | Profit Sharing | Safe Harbor | 401(k) | Total | % | |
| HCE: | ||||||||
| Owner | 45 | 265,000.00 | 175,000.00 | 5,300.00 | 7,950.00 | 18,000.00 | 206,250.00 | 98.20% |
| Subtotal | 265,000.00 | 175,000.00 | 5,300.00 | 7,950.00 | 18,000.00 | 206,250.00 | 98.20% | |
| NHCE: | ||||||||
| Employee 1 | 25 | 30,225.95 | – | 604.52 | 906.78 | – | 1,511.30 | 0.79% |
| Employee 2 | 24 | 25,878.66 | – | 517.57 | 776.36 | – | 1,293.93 | 0.67% |
| Employee 3 | 25 | 13,081.04 | – | 261.62 | 392.43 | – | 654.05 | 0.34% |
| Subtotal | 69,185.65 | – | 1,383.71 | 2,075.57 | – | 3,459.28 | 1.80% | |
| Total | 334,185.65 | 175,000.00 | 6,683.71 | 10,025.57 | 18,000.00 | 209,709.28 | 100.00% | |
A SEP IRA can be setup in a few simple steps:
1. Determine eligibility: Before setting up a SEP IRA, the employer must ensure that they meet the eligibility requirements. The employer must have one or more eligible employees, which include individuals who are at least 21 years old and have worked for the employer for at least three of the past five years
2. Adopt a written plan: The employer must adopt a written plan document that outlines the terms and conditions of the SEP IRA plan. The plan document must include information such as the eligibility requirements, contribution limits, vesting rules, and the plan administrator
Form 5305-SEP is a model Simplified Employee Pension Individual Retirement Account (SEP IRA) plan document that is provided by the Internal Revenue Service (IRS). It is a standardized form that an employer can use to establish a SEP IRA plan for their employees. The form includes a pre-approved plan document that outlines the terms and conditions of the SEP IRA plan. This document includes information such as eligibility requirements, contribution limits, and vesting rules
Using Form 5305-SEP can be a simpler and more cost-effective way for small business owners to establish a SEP IRA plan for their employees, as it can save them the time and expense of drafting their own plan document. However, it’s important to note that employers should review the form carefully and make any necessary modifications to ensure that the plan document meets their specific needs and requirements
Once the employer completes and adopts the Form 5305-SEP, they should provide copies of the plan document to all eligible employees and retain a copy for their records. The employer can then make contributions to each eligible employee’s SEP IRA account according to the terms outlined in the plan document
3. Provide information to employees: The employer must provide all eligible employees with information about the SEP IRA plan, including the plan document, the benefits of participating in the plan, and how to enrol
4. Establish SEP-IRAs: The employer must establish individual SEP-IRAs for each eligible employee, including themselves if they are eligible. This can be done through a financial institution, such as a bank or brokerage firm
5. Make contributions: Once the SEP IRA plan is established, the employer can make contributions to each eligible employee’s SEP-IRA account. The employer can contribute up to 25 percent of the employee’s compensation or a maximum of $61,000 in 2021, whichever is less
6. Maintain records: The employer must keep accurate records of all SEP IRA contributions and transactions. These records may be needed for tax reporting purposes and must be retained for a certain period of time
2. Adopt a written plan: The employer must adopt a written plan document that outlines the terms and conditions of the SEP IRA plan. The plan document must include information such as the eligibility requirements, contribution limits, vesting rules, and the plan administrator
Form 5305-SEP is a model Simplified Employee Pension Individual Retirement Account (SEP IRA) plan document that is provided by the Internal Revenue Service (IRS). It is a standardized form that an employer can use to establish a SEP IRA plan for their employees. The form includes a pre-approved plan document that outlines the terms and conditions of the SEP IRA plan. This document includes information such as eligibility requirements, contribution limits, and vesting rules
Using Form 5305-SEP can be a simpler and more cost-effective way for small business owners to establish a SEP IRA plan for their employees, as it can save them the time and expense of drafting their own plan document. However, it’s important to note that employers should review the form carefully and make any necessary modifications to ensure that the plan document meets their specific needs and requirements
Once the employer completes and adopts the Form 5305-SEP, they should provide copies of the plan document to all eligible employees and retain a copy for their records. The employer can then make contributions to each eligible employee’s SEP IRA account according to the terms outlined in the plan document
3. Provide information to employees: The employer must provide all eligible employees with information about the SEP IRA plan, including the plan document, the benefits of participating in the plan, and how to enrol
4. Establish SEP-IRAs: The employer must establish individual SEP-IRAs for each eligible employee, including themselves if they are eligible. This can be done through a financial institution, such as a bank or brokerage firm
5. Make contributions: Once the SEP IRA plan is established, the employer can make contributions to each eligible employee’s SEP-IRA account. The employer can contribute up to 25 percent of the employee’s compensation or a maximum of $61,000 in 2021, whichever is less
6. Maintain records: The employer must keep accurate records of all SEP IRA contributions and transactions. These records may be needed for tax reporting purposes and must be retained for a certain period of time
In order for contributions to be deductible for the current tax year, the plan must be established by the due date of the employer’s tax return, including extensions.
For example, if you are a sole proprietor and you file your tax return on April 15th, you have until that date (or the extended due date of October 15th) to establish a SEP IRA and make contributions for the previous tax year. If you file your tax return on an extension, you have until the extended due date to establish the SEP IRA and make contributions.
It’s important to note that contributions for the previous tax year can only be made up until the due date of the employer’s tax return, including extensions, so it’s essential to establish the plan by that date if you want to make contributions for the previous year.
For example, if you are a sole proprietor and you file your tax return on April 15th, you have until that date (or the extended due date of October 15th) to establish a SEP IRA and make contributions for the previous tax year. If you file your tax return on an extension, you have until the extended due date to establish the SEP IRA and make contributions.
It’s important to note that contributions for the previous tax year can only be made up until the due date of the employer’s tax return, including extensions, so it’s essential to establish the plan by that date if you want to make contributions for the previous year.
It’s important to communicate with your employees about the plan and their participation in it. Here is some information on employee communications for SEP IRA plans:
1. Disclosure Documents: As an employer, you must provide certain key disclosure documents to your employees, including a copy of IRS Form 5305-SEP and its instructions (or other document used to establish the plan). You should also provide a copy of the plan to eligible employees when they become eligible to participate
2. Written Statement: You must provide a written statement containing information about the terms of the SEP, how changes are made to the plan, and when employees can expect to receive information about contributions to their accounts. This should be provided to employees in writing, either in a document or electronically
3. Annual Statements: The financial institution holding the SEP-IRA accounts will provide an annual statement for each participant, reporting the fair market value of their account. This information should be shared with the employees
4. Copy of Annual Statement Filed with IRS: The financial institution holding the SEP-IRA accounts should provide participating employees with a copy of the annual statement that is filed with the IRS, which contains information on contributions and fair market value
5. Distribution Forms: When an employee receives distributions from their account, the financial institution will send them a copy of the form that is filed with the IRS for the individual’s distribution
6. Notification of Minimum Distribution: The financial institution should notify the participant by January 31 of each year when a minimum distribution is required.
2. Written Statement: You must provide a written statement containing information about the terms of the SEP, how changes are made to the plan, and when employees can expect to receive information about contributions to their accounts. This should be provided to employees in writing, either in a document or electronically
3. Annual Statements: The financial institution holding the SEP-IRA accounts will provide an annual statement for each participant, reporting the fair market value of their account. This information should be shared with the employees
4. Copy of Annual Statement Filed with IRS: The financial institution holding the SEP-IRA accounts should provide participating employees with a copy of the annual statement that is filed with the IRS, which contains information on contributions and fair market value
5. Distribution Forms: When an employee receives distributions from their account, the financial institution will send them a copy of the form that is filed with the IRS for the individual’s distribution
6. Notification of Minimum Distribution: The financial institution should notify the participant by January 31 of each year when a minimum distribution is required.
By providing these key communications to your employees, you can help ensure that they understand the plan and their participation in it. It’s important to work with a financial institution or a qualified financial advisor to ensure that all necessary disclosures are made to your employees, and to make sure that the plan remains in compliance with all IRS rules and regulations.
Unlike some other retirement plans, SEPs are generally not required to file annual financial reports with the Federal Government. SEP-IRA contributions are not included on the Form W-2, Wage and Tax Statement.
The financial institution or trustee handling employees’ SEP-IRAs must provide the IRS and participating employees with an annual statement containing contribution and fair market value information on Form 5498, IRA Contribution Information.
They must also report any distributions it makes from participating employees’ accounts on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The Form 1099-R must be sent to those receiving distributions and to the IRS.
The financial institution or trustee handling employees’ SEP-IRAs must provide the IRS and participating employees with an annual statement containing contribution and fair market value information on Form 5498, IRA Contribution Information.
They must also report any distributions it makes from participating employees’ accounts on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The Form 1099-R must be sent to those receiving distributions and to the IRS.
Participants can make withdrawals at any time. These monies can be rolled over tax-free to another SEP-IRA, to a traditional IRA, or to another employer’s qualified retirement plan (provided the other plan allows rollovers). If a participant withdraws money from a SEP-IRA and does not roll it over to another plan, the withdrawal is subject to income tax for the year in which the employee receives the distribution.
If an employee withdraws money from a SEP-IRA before reaching age 59½, a 10% additional tax generally applies.
Required Minimum Distributions (RMDs): Participants in a SEP-IRA must begin withdrawing a specific minimum amount from their accounts by April 1 of the year following the year the participant reaches the IRS specified age. After this initial year, they must withdraw an additional required minimum distribution amount by December 31 of that year and annually thereafter.
Participants cannot take loans from their SEP-IRAs.
If an employee withdraws money from a SEP-IRA before reaching age 59½, a 10% additional tax generally applies.
Required Minimum Distributions (RMDs): Participants in a SEP-IRA must begin withdrawing a specific minimum amount from their accounts by April 1 of the year following the year the participant reaches the IRS specified age. After this initial year, they must withdraw an additional required minimum distribution amount by December 31 of that year and annually thereafter.
Participants cannot take loans from their SEP-IRAs.
Terminating a Simplified Employee Pension (SEP) plan can occur for a variety of reasons, such as a change in the business structure or a business closure.
If a business decides to terminate its SEP IRA, the first step is to notify the financial institution that handles the SEP-IRA accounts. This notification should include a statement indicating that the business will no longer be contributing to the plan and that the contract or agreement should be terminated. It is also recommended that employees be notified that the plan has been discontinued.
It is important to note that while SEPs are intended to be indefinite, there may be circumstances where the plan no longer serves the needs of the business. In such cases, the business should consult with its financial institution to determine whether another type of retirement plan might be a better alternative.
One of the benefits of terminating a SEP IRA is that the business is not required to give notice to the IRS. However, it is still important to make sure that all necessary paperwork and records are properly maintained in case the IRS has any questions or concerns about the plan’s termination.
It is also important to ensure that any outstanding obligations associated with the plan are resolved before the termination becomes final. This may include ensuring that all contributions for the current year have been made and that all employee accounts have been properly settled.
Overall, terminating a SEP IRA can be a straightforward process as long as the appropriate steps are followed and all necessary parties are properly notified.
If a business decides to terminate its SEP IRA, the first step is to notify the financial institution that handles the SEP-IRA accounts. This notification should include a statement indicating that the business will no longer be contributing to the plan and that the contract or agreement should be terminated. It is also recommended that employees be notified that the plan has been discontinued.
It is important to note that while SEPs are intended to be indefinite, there may be circumstances where the plan no longer serves the needs of the business. In such cases, the business should consult with its financial institution to determine whether another type of retirement plan might be a better alternative.
One of the benefits of terminating a SEP IRA is that the business is not required to give notice to the IRS. However, it is still important to make sure that all necessary paperwork and records are properly maintained in case the IRS has any questions or concerns about the plan’s termination.
It is also important to ensure that any outstanding obligations associated with the plan are resolved before the termination becomes final. This may include ensuring that all contributions for the current year have been made and that all employee accounts have been properly settled.
Overall, terminating a SEP IRA can be a straightforward process as long as the appropriate steps are followed and all necessary parties are properly notified.
