A sample SEP is available in the Business Tools.
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Simplified employee pension plans, as their name implies, allow employers to offer employees retirement benefits with ease in the setting-up process as well as participation and administration. SARSEPs, a form of SEPs, are no longer available but may be maintained if already in existence.
Employers looking for a relatively straight-forward, inexpensive way to offer employees retirement benefits can use a simplified employee pension, or SEP to do so.
Is a SEP right for you? If you fall into one of these categories, you should consider setting up a SEP:
Conversely, you should stay away from SEPs if you:
A sample SEP is available in the Business Tools.
To set up a SEP, you need to take three steps, in the following order:
If you decide to create a SEP, make joining it a condition of employment for all employees. Otherwise, an employee who chooses not to participate could create adverse tax consequences for those who do participate.
There are also several administrative issues involved in offering a SEP, including:
While the "S" in "SEP" stands for "simplified," if you have employees, the process of creating and administering a SEP is not all that simple. If you're interested in establishing a retirement plan, you must consult your financial and legal advisers about how to create and administer the plan.
In setting up a SEP, you have to decide what percentage of compensation you'll use to determine your SEP contributions. This number, known as a contribution allocation formula, is really just a fancy name for figuring out which percentage you will use.
Generally, your SEP contributions must be made in an amount that is the same percentage of total compensation for every employee. Note that this requirement merely obligates you to use the same percentage for every employee; it does not require you to use the same percentage every year (or even to contribute every year).
As a practical matter, you'll want to wait until you know how much money you have available for SEP contributions (usually after the books are closed at the end of the year) before determining the percentage.
After you have determined the percentage and made the contributions, you must give written notice to each participant detailing your contributions to their SEPs. The notice must be made by the later of January 31 of the year following the year for which a contribution is made, or 30 days after the contribution is made.
Let's say you operate on a calendar-year (January to December) basis. After the end of the year, you figure out how much you want to contribute to your employees' SEPs and you make those contributions on January 15. You have until February 14 to give your employees the notice.
Now let's say your fiscal year ends October 31. You make contributions to your employees' SEPs on November 20. You have until January 31 to give your employees the notice.
The next step in setting up your SEP is establishing IRAs for your employees.
The simplest means of setting up employee SEP IRAs is to contact a bank, savings and loan association, insurance company, federally insured credit union, brokerage house, or mutual fund company. Whichever one you contact will supply you with the written documents you need. The language in the IRA shouldn't really vary from one source to another. You should make your choice based on whichever one delivers the best service for the lowest rates. Be sure to run your choices by your business financial adviser.
Who is eligible for an IRA? To be eligible to set up an IRA, your employees must meet two requirements:
You should note that there is no minimum age restriction. Children, therefore, are eligible to have an IRA, as long as they meet the compensation requirement. Children employed by your business, however, are eligible for a SEP only if you have set the minimum age requirements low enough to include them.
The next step in setting up your SEP is completing Form 5305-SEP.
The IRS has developed an extremely helpful one-page tax form that meets all the requirements of a SEP plan. It does not require any special document preparation other than simply filling in a few lines on the form, signing it, and dating it.
To be able to use Form 5305-SEP, you must meet the following requirements:
You should note that even if you fall into one of the categories above, you can still set up a SEP; you just can't use Form 5305-SEP.
Do not file Form 5305-SEP with the IRS. The form is merely intended to help you set up a SEP. You should fill it out, sign it, and date it and keep it with your business records. Once you have filled out the form, you don't have to do anything else with it, which means that you do not have to file Form 5305-SEP with the IRS, and you do not have to file any annual information returns (as most other types of plans are required to do).
In our Business Tools you will find Form 5305-SEP. It is in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.
Once the plan is set up, you must communicate information about the plan to your employees.
If you set up a SEP plan, all eligible employees must be given the following information:
If you have a SEP, be aware that there are strict rules regarding participation. The law mandates that any employee who has reached age 21, has worked for you in at least three of the preceding five years, and has received at least $550 from you for the year (this amount may be adjusted annually for inflation) must be allowed to participate in your SEP. You can write your plan to be more generous if you like (for example, allow employees under 21 or with fewer than three years of service to participate).
You provide your employees with a SEP. Suzanne worked for you while in college in 2010, 2011, and 2012, never working more than 25 days in any particular year. In November 2013, she starts working for you full-time. Suzanne earns $3,000 from you in 2013. She turns 21 on December 31, 2013. You must make a SEP contribution for Suzanne for 2013 since she met the minimum age requirement, has worked for you in three of the five years preceding 2013, and has met the minimum requirement for 2013.
There are a couple of points you should remember about participation:
There are rules limiting SEP contributions as well.
Again, the maximum annual contribution you can make to a SEP is the lower of 25 percent of an employee's pay up to $260,000 or $52,000 (for 2014; these amounts may be adjusted annually for inflation).
If you're self-employed, the limits are slightly lower. When figuring the deduction for employer contributions made to your own SEP-IRA, compensation is your net earnings from self-employment, which takes into account:
The end result is that you will have to reduce the contribution rate called for in your plan by using a table and worksheets provided by the IRS in Publication 590, Individual Retirement Arrangements (IRAs).
The Contributions and Deductions Table and Worksheets for the Self-Employed, which may be used to determine the deductibility of your contributions to your retirement plan, have been included in the Business Tools.
When an employee becomes vested in a retirement plan, it means that he or she has participated in a plan long enough or has provided enough years of service to an employer such that the employee becomes entitled not only to the contributions that the employee might have made (which is not applicable in a SEP) but also to the contributions made by the employer. In plans other than SEPs, if an employee is not vested in a plan, the employee is not entitled to the contributions made by the employer.
In traditional pension plans, employers generally set up a vesting schedule. For example, they might provide that an employee is 33 percent vested after three years, 66 percent after four years, and 100 percent after five years. SEPs are different. The employee's right to employer contributions in a SEP is always 100 percent vested. Therefore, your employee has the full ownership right to the contributions in the account at all times.
Even so, there are penalties for early withdrawals. Since SEPs are based on IRAs, the IRA penalties apply. If an employee who has not reached age 59 1/2 makes an early withdrawal, the employee will have to pay a 10 percent penalty tax. In addition to the 10 percent tax, the employee must include the distribution in income for the year in which it was received. As with regular IRAs, penalties can be avoided if the employee rolls the amount over into another IRA within 60 days.
Salary reduction simplified employee pension plans (SARSEPs) are a type of pension plan that, as of 1997, are no longer available. Those who already have such plans can continue to contribute to them, and add accounts for new employees, but no new SARSEPs can be set up.
SARSEPs are SEPs that act like 401(k) plans in the sense that employees who participate in the SARSEP can elect to have salary-reduction contributions made to the SEP, just as they can in a 401(k) plan.
Among the Business Tools is a SARSEP checklist intended to aid in keeping SARSEP plans in compliance with tax rules. It is in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.
The amount that can be deferred in a SARSEP is $17,500 or 100 percent of compensation, whichever is less, for 2013 and 2014 (this amount may be adjusted annually for inflation). Additional catch-up contributions are allowed for employees who have reached age 50. Catch-up contributions are limited to $5,500 for 2013 and 2014 (this amount may be adjusted annually for inflation).
To participate in a SARSEP, an employee must be at least 21, must have worked for you in at least three of the preceding five years, and must have received at least $550 in compensation for the year in which the contribution was made. The compensation amount may be adjusted annually for inflation.
The election to use a SARSEP is available only if:
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