Simplified Employee Pensions, known as SEPs, represent an easy, low-cost retirement plan option for employers. Instead of establishing a separate retirement plan, in a SEP the employer makes contributions to his or her own Individual Retirement Account (IRA) and the IRAs of his or her employees, subject to certain percentages of pay and dollar limits. Employers who establish SEPs can:

§                     Make tax deductible contributions to their own and their employees' IRAs.

§                     Omit or reduce contributions in years when contributions are unaffordable.

§                     Avoid the administrative costs and the reporting requirements of conventional plans.

Whether a SEP is appropriate for your business will depend on factors such as revenue, firm size and the age, compensation and retirement needs of the business owner and work force. You may want to discuss other retirement plan options with a professional advisor.

 

What Are SEP-IRAs

SEPs are retirement programs established by you, as an employer, which allow you to provide retirement benefits for yourself and your employees without paying the start-up and operating costs of conventional plans.

SEPs allow an employer to establish and make contributions to IRAs. The two critical differences between SEP-IRAs and other IRAs are that:

§                     SEP contributions are generally made by employers, not employees.

§                     The amounts contributed to SEPs can be much larger than the amounts contributed to IRAs.

As a general rule, up to 15 % of each employee's pay, including your own, can be put into a SEP-IRA each year.

 

Why Set-Up a SEP

Advantages for you as an employer:

§                     A SEP can provide a significant source of income at retirement.

§                     Contributions to a SEP are tax deductible and your business pays no taxes on the earnings on a SEP's investments.

§                     You are not locked into making contributions in future years. You can decide each year whether to pay into the SEP and how much to contribute.

§                     Once you put money into a SEP you have no further responsibility for the amounts contributed. The funds are managed by a financial institution.

§                     A SEP can be established and operated without the administrative expenses, consulting fees or commissions usually associated with maintaining a conventional retirement plan.

§                     You ordinarily do not have to file any documents with the government.

§                     SEPs can be set up by sole proprietors, partnerships and corporations, including S corporations.

§                     You can deduct contributions to a SEP for a previous tax year if you make contributions by the due date of the employer's tax return, including any extensions.

 

Advantages For Your Employees

§                     The money you contribute to your employees' SEP accounts, as well as the investment earnings, belongs to them, even if they stop working for you.

§                     Employers' contributions to the SEP-IRA are not included in employees' income for income tax purposes.

§                     Employees pay no taxes on the amounts in their SEP accounts until they start withdrawing the funds.

§                     Employees can change the financial institution where their SEP is invested.

§                     In case of an employee's death, the assets in a SEP will go to someone the employee has chosen.

§                     SEP contributions can continue until employees retire, but they must start withdrawing assets from a SEP when they reach age 70½.

 

Establishing a SEP

You can set up a SEP by using the Internal Revenue Service's "Model SEP" agreement Form 5305-SEP. All you have to do is:

§                     Decide the percentage of pay you want to contribute to the SEP.  The contribution is limited to 15% of pay or $24,000* (for 1997), whichever is smaller.  A uniform percentage of pay must be contributed for each employee.  This number is indexed for inflation each year.

§                     Fill out Internal Revenue Service Form 5305-SEP, a quarter-page form with six blank spaces. This form is not filed with the Internal Revenue Service.

§                     Set up an IRA at a financial institution to receive your SEP contributions. An IRA can be set up by or for your employees to receive the contributions you make for them.

§                     Mail the SEP contributions to the financial institutions.

§                     Give employees eligible to be included in the SEP a completed copy of the Form 5305-SEP and the other documents and disclosures listed in the instructions, including an annual statement to each participating employee of the amounts contributed to their account for the year.

No other reporting or disclosure ordinarily is required.

You cannot use the IRS "Model SEP" if you currently maintain any type of qualified retirement plan or have ever maintained a pension plan for yourself and your employees that promised to pay specific benefits at retirement -- a "defined benefit" pension plan. You also cannot use the Model SEP if you have any eligible employees for whom accounts have not been established. For this purpose, eligible employees include certain individuals who have a specific relationship to the employer. For example, eligible employees for purposes of SEP contributions include "leased employees", and members of an "affiliated" or "commonly controlled" group of employers of which you are a member. These are technical terms that are defined in the Internal Revenue Code. For example, the term " leased employees" is defined in section 414(n) of the Code. The term, "affiliated group" is defined in Code section 1504, and the term "controlled group" is defined in Code section 1563. If you believe any of these terms apply to you, you should consult a professional advisor.

Although using the IRS Form 5305-SEP is an easy way to set up a SEP, you do not have to use this model agreement. Many financial institutions have their own SEP arrangements that have been approved by the Internal Revenue Service. In addition, employers may design their own SEP subject to the legal requirements.

If you use a non-model SEP, the law allows you to take into account Social Security contributions you made for your employees. If you want to do this, consult your professional advisor.

 

Who Must Be Included In a SEP

Generally, any employee who performs services for certain affiliated or commonly controlled employers (see the discussion on page 6 regarding these terms) must be included in a SEP. However, there are five exceptions to this general rule. Employers may exclude from the SEP:

§                     Employees who have not worked for the company during three out of the last five years.

§                     Employees who earn less than $400* (for 1997) a year.  This number is indexed for inflation each year.

§                     Employees who have not reached age 21 during the calendar year for which contributions are made.

§                     Employees covered by a collective bargaining agreement, if retirement benefits were the subject of good-faith bargaining.

§                     Non-resident immigrants who do not earn U.S. source income from you.

 

Salary Reduction SEPs

Starting January 1, 1997, employers may no longer set up Salary Reduction SEPs. However, the Small Business Job Protection Act of 1996 (Public Law 104-188) established Savings Incentive Match Plans for employees involving IRAs--known as the SIMPLE IRA. Employers may set up a SIMPLE IRA which allows salary reduction contributions of up to $6,000 annually.

If an employer had a salary reduction SEP in effect on December 31, 1996, the employer may continue to allow salary reduction contributions to the plan. Employees are generally permitted to contribute up to 15% of pay or $9,500* (for 1997) a year, whichever is less, to a Salary Reduction SEP, provided the employee earns at least $400 (for 1997).  This number is indexed for inflation each year.

There are certain maximum permissible amounts that may be contributed on behalf of company owners and certain highly-paid employees ("highly compensated employees") in comparison to amounts contributed for other eligible employees. The amount (percentage of pay) contributed for these highly compensated employees cannot be more than 125% of the average percentage of pay contributed by all other eligible employees. Employers must notify employees by March 15 of the following year if the contributions for the preceding year exceed the limits.

An employer can have both an employer-funded SEP and a Salary Reduction SEP. The total amount contributed for any employee, however, cannot be more than 15% of pay.

 

SEP Investments

Financial institutions authorized to hold and invest SEP contributions include banks, savings and loan associations, insurance companies, certain regulated investment companies, federally-insured credit unions and brokerage firms. SEP contributions can be put into stocks, mutual funds, money market funds, savings accounts and other similar types of investments.

You and your employees will receive a statement from the financial institutions investing your SEP contributions both at the time you make the first SEP contributions and at least once a year after that. Each institution must provide a plain-language explanation of any fees and commissions it imposes on SEP assets withdrawn before the expiration of a specified period of time.

 

Frequently Asked Questions About SEPs

If an employer maintains a SEP for its employees, can the employees also make contributions to Individual Retirement Accounts?

Yes. If the employees choose to do so, they may combine IRA and SEP contributions in one account. NOTE: Because SEP contributions make an individual an "active participant in a qualified plan" for IRA purposes, IRA contributions of certain employees may not be tax deductible. See IRS Publication 590.

 

Can an employee eligible to participate in a SEP choose not to participate?

No. All eligible employees must participate. An employer can set up an IRA for the employee at a financial institution and make the appropriate contribution.

 

Does the employer have to pay Social Security or federal unemployment compensation taxes on SEP contributions for employees?

No.

 

Do employers in companies with Salary Reduction SEPs have to pay Social Security taxes on their employees' pre-tax contributions?

Yes. In addition, employees have to pay their portion of Social Security taxes.

 

When are income taxes paid on money in a SEP account?

Income taxes are paid when money is withdrawn from a SEP account.

 

When can money be withdrawn from a SEP account?

SEP money can be withdrawn without penalty at age 59½. Earlier withdrawals are generally subject to a 10% additional income tax unless the participant becomes disabled or receives distributions in the form of an annuity that are part of substantially equal payments over life or life expectancy