SEP

A SEP is a simplified employee pension plan. A SEP plan provides employers with a simplified method to make contributions toward their employees’ retirement and, if self-employed, their own retirement. Contributions are made directly to an Individual Retirement Account or Annuity (IRA) set up for each employee (a SEP-IRA). Employer contributions to a SEP-IRA are 100% vested to the employee and are not included in the employee's gross taxable income. According to ICI, SEPs (and their predecessor SARSEPs) held an estimated $180 billion dollars of assets as of 2008.

Establishing an SEP
According to the IRS, there are three basic steps involved in setting up an SEP.


 * A formal written agreement must be executed. This written agreement may be satisfied by adopting an Internal Revenue Service (IRS) model SEP using 5305-SEP, Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement. A prototype SEP that was approved by the IRS may also be used. Approved prototype SEPs are offered by banks, insurance companies, and other qualified financial institutions. Finally, an individually designed SEP may be adopted.


 * Each eligible employee must be given certain information about the SEP. If the SEP was established using the Form 5305-SEP, the information must include a copy of the Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions. If a prototype SEP or individually designed SEP was used, similar information must be provided.


 * A SEP-IRA must be set up for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. The SEP-IRA is owned and controlled by the employee and the employer sends the SEP contributions to the financial institution where the SEP-IRA is maintained.

Eligible Employees
Generally, any employee who performs services for a business must be included in a SEP. However, there are some exceptions to this general rule. Among the employees that may be excluded from a SEP are those who:


 * Have not worked for the company during three out of the last five years.
 * Have not reached age 21 during the year for which contributions are made.
 * Are employees who are covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees’ union and you.
 * 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 in 2009, subject to cost-of-living adjustments in later years.

A SEP cannot have a last-day-of-the-year employment requirement. Eligible employees must share in any SEP contribution. This includes eligible employees who die or quit working before the contribution is made.

Contributions for a year must be deposited by the due date (including extensions) for filing the business Federal income tax return for the year.

Contributions
Most SEPs, including the IRS model Form 5305-SEP, require that allocations to all employees' SEP-IRAs be proportional (the same percentage of salary/wages be contributed for all participants) to their salary/wages. A self-employed owner’s contribution is based on net profit minus one-half self-employment tax minus the contribution for him or herself. See IRS Publication 560on determining the contribution amount. Contributions are not required to be made every year, but in years contributions are made to the SEP, they must be made to the SEP-IRAs of all eligible employees.

Annual contributions an employer makes to an employee’s SEP-IRA cannot exceed the lesser of:


 * 1) 25% of compensation, or
 * $49,000 for 2009 and subject to annual cost-of-living adjustments for later years.

These limits apply in the aggregate to contributions an employer makes for its employees to all defined contribution plans, which includes SEPs. Only up to $245,000 in 2009 (subject to annual cost-of-living adjustments for later years) of an employee’s compensation may be considered. Contributions must be made in cash. Property cannot be contributed.

Distributions
Withdrawals from a SEP-IRA are taxable. Withdrawals prior to age 59 1/2 are subject to a 10% penalty tax. Required Minimum Distributions must begin by the age of 70 1/2 for retired individuals.

Competitive Alternatives
Employer's with businesses that have employees should compare an SEP with a SIMPLE IRA. Self-employed individuals should compare an SEP with an Individual 401k Plan. The Vanguard tool, Which retirement plan is right for you?, can provide guidance for plan selection.

Links

 * IRS Publication 560: Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans)
 * IRS SEP
 * SEP Retirement Plans for Small Businesses Department of Labor