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A Simplified Employee Pension (SEP) plan is one of the easiest and uncomplicated methods for self-employed or small business owners to contribute to their staff (and their own) retirement funds. As the name suggests, it was originally setup to simplify the entire employer-sponsored retirement fund process and make it a more welcoming environment for small business owners to enter.
By setting up a SEP plan for their business, owners are then allowed to participate in their employees’ individual retirement account (IRA). This can be done through topping up the employee’s contributions or approved deductions from an employee’s salary. Thus, through the creation of a SEP and the subsequent contributions to the IRA, a SEP-IRA is formed.
Anyone receiving contributions through a SEP must have a Traditional IRA set up beforehand. In some cases banks may require the IRA to be explicitly labeled as a SEP-IRA to receive outside contributions from an employer.
Because the SEP-IRA is just another vehicle for retirement investing it follows the same rules as Traditional IRAs. This means meeting the requirements for distribution and investment, as well as the rules surrounding contributions or deductions for individuals. It should be noted that many of the rules regarding the contribution limits (or deductions) cover the IRA in general and not merely the SEP portion of the plan. For more information on these Traditional IRA rules be sure to check out the resources online, most important of which is by the IRS.
A SEP-IRA plan can be extremely beneficial to both the employee and the employer (even when they are the same). For many employers, the SEP program offers an excellent alternative to the complicated and expensive qualified programs on the market. A qualified retirement plan is essentially more structured. In most cases, they place more risk and liability onto the employer because they are required to meet the investment obligations. One of the most common forms of a qualified plan is a pension.
A SEP-IRA is much simpler to administer and has lower startup and annual costs for the employer. On top of this, there is no annual requirement for contributions by the organization. Each year companies can make decisions on how much, if any, they wish to contribute to their employees’ retirement funds.
Who Can Apply for a SEP-IRA?
Perhaps one of the best aspects about a SEP-IRA is that it is open to any employer to start. This includes many different company structures, such as non-profits, for-profits, large corporations, partnerships, or even those who choose the route of a sole proprietorship. Unlike many other federal business programs, the SEP-IRA is open to owner-operators who also happen to be the only employee.
While individual employees can benefit from their employer setting up a SEP-IRA, employees cannot simply set up a SEP on their own. The organization is responsible for the administration of the SEP, and the employee is responsible for their IRA.
Each business develops their own SEP eligibility requirements. From business to business the minimum requirements can be adjusted, but according to the federal government, employees cannot be excluded from the SEP-IRA if:
- The employee is 21 years of age or older.
- The employee has made at least $600 per year (2016/2017 year)
- The employee worked for the business for three out of the last five years.
Most sources on the subject recommend that employers ensure that they do not exclude themselves upon the implementation of the above requirements. For example, if the owner is under 21 years old or perhaps if they recently purchased the company within the past two years, the owner may want to change the minimum eligibility requirements to ensure they can also reap the benefits.
How to Set Up a SEP-IRA
Again, one of the best features of the SEP-IRA is its ease. If the steps are boiled down into easy to digest portions, there are three main actions involved. Most online brokers can not only help an employee set up the required IRA account, but can also assist the employer in establishing the SEP itself.
1. Sign a Formal Written Agreement
The first, and perhaps most important, step is to sign the formal SEP-IRA contribution agreement. While most SEP-IRA arrangements use Form 5305-SEP, available directly from the IRS, other approved SEP agreements are available through private institutions, like insurance companies and financial institutions. It may be beneficial to discuss the options available to your organization through companies you already do business with. If neither of these options work for your organization, customized agreements can be drafted by qualified organizations to suit your company’s needs better.
To qualify for the current year, a SEP-IRA must be set up on or before the yearly deadline for a company’s income taxes. If it is signed afterward, the agreement only comes into place for the following year.
2. Notify All Eligible Employees
Once the plan is established it is important to introduce the plan to all eligible employees to ensure they are aware of the possible retirement benefits available to them. For those employers using Form 5305-SEP, it’s a straightforward process of providing employees with a copy of that form. If an employer is using a more individualize SEP plan then more documentation may be required to ensure the employees are adequately familiarized with the plan. In essence, the employees need to know who is eligible, what rules apply, and how the employer will be involved in their retirement investments.
3. Set up the SEP-IRA for Each Employee
The final step needs to be completed for each employee participating in the program. Each employee needs to have a SEP-IRA set up through their financial institution, insurance company, or even an online broker. Once it has been established, the employee, and not the employer, is the owner and operator of the plan.
Author: Jeff Gitlen