SEP Plan Fix-It Guide - SEP Plan Overview
A SEP is a Simplified Employee Pension plan. To establish a SEP, the employer:
- Can be a business of any size, even self-employed
- Must adopt a SEP plan document
Any employer - including a sole proprietorship, partnership, corporation and nonprofit organization - with one or more employees may establish a SEP plan. This includes a self-employed business owner, regardless of whether he or she is the only employee of the business. Individual employees may not establish a SEP plan.
Under a SEP, the employer contributes to traditional IRAs set up for eligible employees (including self-employed individuals), subject to certain limits. A SEP is funded solely by employer contributions. Each employee is always 100% vested in (or, has ownership of) all money in his or her SEP-IRA.
There are three basic steps in setting up a SEP.
- Execute a formal written agreement to provide benefits to all eligible employees.
- Give employees certain information about the SEP.
- Set up a SEP-IRA for each eligible employee.
Formal written agreement. You must execute a formal written agreement to provide benefits to all eligible employees under a SEP. You can satisfy the written agreement requirement by adopting an IRS model SEP using Form 5305-SEP.
If you use Form 5305-SEP, no prior IRS approval or determination letter is required. Keep the original form. Don't file it with the IRS. Also, using Form 5305-SEP will usually relieve you from filing annual retirement plan information returns with the IRS and Department of Labor. See the Form 5305-SEP instructions for details.
When not to use Form 5305-SEP. You cannot use Form 5305-SEP if you:
- Currently maintain any other qualified retirement plan.
- Have any eligible employees for whom you haven't set up IRAs.
- Use the services of leased employees.
- Are a member of any of the following, unless eligible employees of all the members of these groups, trades or businesses participate under the SEP.
- An affiliated service group described in Internal Revenue Code Section 414(m)
- A controlled group of corporations described in IRC Section 414(b)
- Trades or businesses under common control described in IRC Section 414(c)
Use of prototype SEPs. Financial institutions and other approved sponsoring organizations can sponsor a prototype SEP document. The IRS issues opinion letters approving prototypes. Plan sponsors can use individually designed documents, but the IRS hasn't established an approval process for these.
Information you must give to employees. You must give each eligible employee a copy of Form 5305-SEP, its instructions and the other information listed in the Form 5305-SEP instructions. An IRS Model SEP isn't considered adopted until you give each employee this information. If you adopt a prototype SEP, you must give each eligible employee similar information.
Setting up the employee’s SEP-IRA. A SEP-IRA must be set up by or for each eligible employee. SEP-IRAs can be set up with banks, insurance companies or other qualified financial institutions. You send SEP contributions to the financial institution where the SEP-IRA is maintained.
Deadline for setting up a SEP. A SEP can be set up for a year as late as the due date (including extensions) of the business’s income tax return for that year.
Who is eligible to participate?
Generally, any employee who performs services for the business must be included in a SEP. However, there are some exceptions to this general rule. Among the employees that you may exclude from a SEP are those who:
- Haven't worked for you during three out of the last five years.
- Haven't reached age 21.
- Are employees who are covered by a union agreement and whose retirement benefits were bargained for in good faith by you and the employees’ union.
- Are nonresident alien employees who have received no U.S. source wages, salaries or other personal services compensation from you.
- Received less than $550 in compensation (subject to cost-of-living adjustments) during the year. Gross wages reported on Form W-2 can be used to determine if an employee is eligible to participate.
What are the contribution requirements?
By establishing a SEP, you've adopted a plan that requires a SEP-IRA to hold the contributions made for each of the eligible employees. A SEP is funded by employer contributions. The SEP plan document will indicate the amounts you've agreed to contribute. This amount can be discretionary, including zero. The SEP document must include a definite written allocation formula for determining how the contribution is allocated to the employees’ SEP-IRAs.
SEP contributions must bear a uniform relationship to compensation. Generally, a uniform relationship means that each employee’s contribution must represent the same percentage of compensation. Nonuniformity is possible with a permitted disparity formula (see IRC Section
Total contributions to each employee’s SEP-IRA cannot exceed the lesser of $52,000 for 2014, (subject to cost-of-living adjustments for later years) or 25% of compensation. Each employee is always 100% vested in (or, has ownership of) all contributions to his or her SEP-IRA.
After you send the SEP contributions to the financial institution, it will manage the funds. Depending on the financial institution, SEP contributions can be invested in individual stocks, mutual funds and other, similar types of investments.
Each participating employee must receive an annual statement stating the amount contributed to the SEP-IRA for the year.
What are the basic distribution/withdrawal rules?
Employees can withdraw SEP contributions and earnings at any time. A withdrawal is taxable in the year received. If an employee makes a withdrawal before he or she is age 59½, generally a 10% additional tax applies. Employees may roll over SEP contributions and earnings tax-free to other IRAs and retirement plans.
SEP contributions and earnings must eventually be distributed. A specific minimum amount is required to be distributed by April 1 of the year following the year the employee reaches age 70½.
What are the filing requirements?
An employer generally has no filing requirements. The annual reporting required for qualified plans (Form 5500 series) is normally not required for SEPs. The financial institution that holds the plan’s SEP-IRAs handles most of the other paperwork, including Form 5498, an annual document issued by the financial institution to report information to the IRS about amounts contributed to the SEP-IRAs.