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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 taxes are 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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Related Content
- Return to the Retirement Plans Table of Contents to find related links