Simplified Employee Pension Plans (SEP IRAs)
The Simplified Employee Pension Plan (SEP) is a retirement plan with minimal administrative and operating costs and no filing requirements, unlike conventional retirement plans. In other words, this plan is highly suitable for small business owners and their employees, if eligible. Individual SEP-IRA plans are setup for the employer and all eligible employees. Contributions of up to 25% of each employee’s pay can then be directed into each of the separate accounts. The SEP-IRA offers tax-deductible contributions for the employer and tax deferred earnings for all participants.
You can set up an SEP if you are a business owner which includes sole proprietorships, partnerships and corporations including S corporations. You are also eligible if you have a self-employed income, which may be part or full time. You are still eligible if your self-employed income is an additional source of revenue, while you are covered by an employer sponsored retirement plan under your regular job. Employers are eligible for annual tax credits of up to $500 to offset the SEP plan operating costs for the first three years of the plan. Qualified plans must be set up by the end of the fiscal year ( Dec 31st), while the SEP may be established as late as the company’s income tax return due dates.
An SEP can be opened with most financial institutions, who then undertake the responsibility of receiving and investing the contributions made to each SEP-IRA account, IRS filings and providing all participants with annual statements detailing all employer contributions and gains made by the account. The employer has no filing requirements and is free to decide how much to contribute into the SEP-IRA’s each year. The IRS does have guidelines for a standard SEP plan, while financial institutions have their own variations which follow the IRS guidelines. All the employer is required to do is fill up the IRS form 5035-SEP and provide a copy to each participating employee.
The employer can deduct and transfer up to 25% of annual compensation into an employee’s SEP-IRA. The maximum allowed compensation for the year 2007 is $225,000. The IRS also gives wide latitude to the employer to define the eligibility criteria for employees, which includes considering your self as an owner-employee with earned income and part-time, leased or otherwise temporary help. The defining parameters for an eligible employee is one who is at least 21 years or older and has provided some services during at least 3 of the past 5 years.
Participants cannot take loans against the funds in the SEP-IRA. However, cash withdrawals and transfers to another SEP-IRA or any other IRA is allowed. Withdrawals are subject to income tax and a 10% early withdrawal penalty ( conditions apply ) but transfers can be made tax free.
As a small business owner, setting up an SEP and offering SEP-IRA plans to your employees carries many advantages including tax deductions and being able to attract more qualified help. With no administrative overheads and a high degree of flexibility regarding contributions, the SEP-IRA is an attractive tax deferred savings vehicle for both employer and employees. You are advised to consult your financial planner to help you decide exactly which SEP, what kind of arrangement and which financial institution is suitable for you and your employees.