Learn about SEP plans:
What is an SEP?
SEP stands for Simplified Employee Pension. An SEP enables employers to set aside money in tax deferred retirement accounts for themselves and their employees. SEPs do not have the start up costs of conventional retirement plans, making them an attractive option for small businesses.
Am I Eligible for a SEP Plan?
As a business owner, whether incorporated or not, you may establish a SEP plan. Sole proprietors and partnerships can have SEP plans, even if there are no employees. However, if you currently maintain a qualified retirement plan, you cannot establish the Internal Revenue Service (IRS) model SEP plan for your business.
What is the Maximum SEP Contribution?
Under the IRS model SEP plan, you must contribute a uniform percentage of compensation for each eligible employee. The maximum contribution is the lesser of the contribution amount or 25 percent of each employee’s compensation.
For an employee, compensation is generally the Form W-2 wages from the employer sponsoring the SEP plan. For a self-employed person, compensation is his/her earned income from selfemployment. Special adjustments to compensation are necessary before a self-employed person can apply the desired contribution percentage.
Do I Get a Tax Deduction for My SEP Plan Contributions?
Yes! Dollars you contribute on behalf of yourself and your employees, within the previously-mentioned limits, are generally deductible as a business expense. A self-employed individual claims his/her personal SEP plan contribution as an adjustment to gross income on his/her personal income tax return.
Must I Contribute for Each of My Employees?
No. The SEP plan may exclude certain employees from an annual SEP plan contribution because of:
Age—A SEP plan may exclude employees who are younger than 21 years of age. However, an employer must contribute for any eligible employee who is older than age 21, even those over age 70.5.
Must I Contribute the Same Percentage Each Year?
No. You have until the due date of your business’s federal income tax return to determine your SEP plan contribution each year. If you wish, you may skip the contribution entirely for any year.
What Happens to the Assets After I Make SEP Plan Contributions?
All SEP plan contributions are made to eligible employees’ traditional IRAs. Once the SEP contribution has been made, each employee’s account will be subject to all of the traditional IRA rules. These include limits on withdrawals prior to age 59.5 and required minimum distributions at 70.5.
What Happens to My Account in the Event of My Death?
Your named beneficiary(ies) will receive the rights to your account. Distributions to the beneficiary(ies) will be made in accordance with required minimum distribution rules and your IRA plan agreement.
May I Have a Traditional or Roth IRA in Addition to a SEP Plan?
Yes. You and your employees may contribute to traditional and/or Roth IRAs if eligible. If a SEP plan contribution is made, you are considered an active participant in an employer-maintained retirement plan. Therefore, the deductibility of your traditional IRA contribution will depend on your modified adjusted gross
income and income tax-filing status.
Is it Difficult to Establish a SEP Plan?
No. To establish an IRS model SEP plan, you must complete an IRS-approved form, provide a copy to each eligible employee, and have each of them establish a traditional IRA.
When Can I Establish a SEP Plan?
The deadline for establishing or contributing to a SEP plan is your business’s income tax-filing deadline, including extensions.
Is There a Tax Credit Available to Start a SEP Plan?
Yes. A tax credit under Internal Revenue Code 45E is available to offset pension plan startup costs for eligible small employers. The amount of the credit is 50 percent of a plan's qualified startup costs, not to exceed $500 for the first year and the two taxable years immediately following.
An eligible employer uses IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs, to claim the credit. The tax credit is available for costs paid or incurred in the first three plan years. Contact your tax or legal professional to determine your eligibility for this tax credit.
This information is intended to provide general information on federal tax laws governing simplified employee pension plans. It is not intended to provide legal advice or to be a detailed explanation of the rules or how such rules may apply to an employer’s individual circumstances. For specific information, an employer should consult a tax or legal professional. IRS Publication 560, Retirement Plans for Small Business, IRS Publication 590, Individual Retirement Arrangements (IRAs), and the IRS’s web site, www.irs.gov, may also provide helpful information.