18 Things to Know About SEP Plans

1. Employer Established

A SEP (Simplified Employee Pension) is an employer-established plan and contributions are made by the employer to his or her own SEP-IRA account and to each employee's SEP-IRA account. Employees cannot set up their own SEP or make contributions to their own SEP-IRA account.

A SEP-IRA account is a traditional IRA and follows the same investment, distribution, and rollover rules as traditional IRAs.

2. Written Arrangement

A SEP is a written arrangement. It provides a simple, tax favored way for you to provide for your own retirement and to help employees save for theirs.

3. Self-Employed Persons

If you're self-employed, you can set up a SEP-IRA for yourself and make tax deductible contributions towards your own retirement.

Contributions to a SEP-IRA and its earnings are tax-deferred until distributed.

4. IRA-Based

Because SEP IRAs are IRA-based, they are simpler and less expensive to set up and administer than qualified plans, such as 401(k) plans, which involve more complex rules.

5. Control

A SEP-IRA is owned and controlled by the employee.

Keep in mind, normally, for income tax purposes, a self-employed person is not considered an employee of his or her business. However, for retirement plan purposes, a sole proprietor is treated as his or her own employer and partners are treated as employees of the partnership entity.

6. Reporting Requirements

There are no annual reporting requirements for a SEP.

7. Vesting

Contributions by the employer for plan participants are immediately 100% vested for each plan participant (the money belongs to them).

8. Corporations

Corporations can also use SEPs.

9. Form W-2 reporting for SEP-IRA contributions

SEP-IRA contributions are not included in an employee's gross compensation on Form W-2 (e.g., wages, salary, bonuses, tips, commissions).

SEP-IRA contributions are not subject to:

  • Federal income taxes, or
  • Social security and Medicare taxes

10. FUTA Tax

SEP-IRA contributions are not subject to FUTA tax.

11. Additional are taxes imposed for the following

  • Making excess contributions
  • Making early withdrawals
  • Not making required withdrawals (e.g., like any traditional IRA, you must start receiving distributions at age 70 1/2).

12. Who can participate in a sep plan?

Self-employed individuals and eligible employees may participate in a SEP plan.

An eligible employee must meet three requirements:

  • Has reached age 21
  • Has worked for you in at least 3 of the last 5 years.
  • Has received at least $550 in compensation from you for tax year 2012.

13. Setting up a sep plan and SEP-IRA accounts

Three basic steps in setting up a SEP:

  • Execute a formal written agreement.
    • IRS Form 5305-SEP can be used to establish a SEP plan.
    • You do not file Form 5305-SEP with the IRS; you keep it for your own records.
  • Give certain information about the SEP to each eligible employee.
  • Set up traditional SEP-IRA accounts for each plan participant.
    • A SEP-IRA must be a traditional IRA; it may not be designated as a Roth IRA.

14. Timing Deductible Contributions

You can set up a SEP and make deductible contributions as late as the due date of your return plus extensions.

15. Contributions

  • Self-Employed:
    • You make plan contributions into your own SEP-IRA account.
  • Employees:
    • The employer makes contributions directly into each plan participant's SEP-IRA account at the financial institution where the SEP-IRA account is maintained
    • You, as the employer, do not withhold any money from an employee's pay to make plan contributions unless the SEP is a pre-1997 salary reduction simplified employee plan or a SIMPLE plan.
    • Employees are not permitted to make contributions to their own SEP-IRA. Only the employer may make SEP-IRA contributions.
  • Contributions must be in the form of money (cash, check, or money order).
    • An employer cannot make contributions on the condition that any part of them must be kept in the employee's SEP-IRA account.
    • Contributions to am employee's SEP-IRA belong to the employee with no strings attached.

16. How to deduct contributions

  • Employees:
    • Contributions for common-law employees are an allowable business deduction and are deducted directly from business income.
    • For example, a sole proprietor deducts contributions made for employees on Schedule C
  • Self-employed persons:
    • Contributions for yourself (if you're self-employed) are deducted on Form 1040, line 28 in arriving at adjusted gross income (AGI).
    • A special computation must be made to figure your own deduction.

17. Distributions, rollovers, withdrawals

As an employer, you cannot prohibit distributions from a SEP-IRA. Generally, you can withdraw funds anytime. However, they will be subject to income taxes.

Distributions from a SEP-IRA are subject to IRA rules (e.g., early withdrawals before 59 1/2 are subject to a 10% penalty-with certain exceptions), including tax treatment of:

  • Distributions
  • Rollovers
  • Required distributions, and
  • income tax withholding

18. Borrowing From a SEP

There are several prohibited transactions; borrowing from a SEP is one of them because it is considered an improper use of SEP-IRA funds.

There are consequences for engaging in prohibited transactions.

  • If an employee engages in a prohibited transaction the SEP-IRA will no longer qualify as an IRA.
  • If a SEP-IRA is disqualified because of a prohibited transaction, the assets in the account will be treated as having been distributed to the employee on the first day of the year in which the transaction occurred.
  • The employee must include in income the fair market value of the assets (on the first day of the year) that is more than any cost basis in the account.
  • The employee may have to pay the additional tax for making an early withdrawal (10% of the amount withdrawn) if under age 59 1/2.

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