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Simplified Employee Plan (SEP)

The Basics: A SEP provides an employer with a simplified way to make contributions to an employee's individual retirement account or individual retirement annuity.

Employer contributions are made directly to SEP-IRAs set up for each employee with a bank
insurance company or other qualified financial institution.

Employer contributions are tax deductible. (IRC Sec. 404)

Contributions are not taxed currently to the emplovee. IRO Sec. 402(b)

Earnings accumulate income tax-deferred. IRC Sec. 501(a)

How Much Will There Be At Retirement?

This will depend upon three factors:

  1. The frequency and amount of contributions,
  2. The number of years until retirement, and
  3. The investment return.

The risk of poor investment returns rests upon the employee. However, if the investment results are favorable, the participant will have a larger fond at retirement age.

Top-Heavy Plans

If more than 60% of the plan assets are allocated to "key employees," then the employer must contribute at least as much for "non-key" participants as it does for key employees. This requirement applies only to a contribution of up to the first 3% of includable compensation.

Additional Considerations

Annual Contribution: No annual contribution is required, If a contribution is made and IRS Form 5305-SEP is used as the plan document, the allocation must be the same percentage for each eligible employee. Allocation formulas which favor older employees may not be used. if integration with Social Security is desired.  A custom plan or prototype document must be used.

Individual Limits: The allocation of employer contributions to a participant's account may not exceed the lesser of 15% of compensation or $30,000, For the self-employed, these values are 13.0433% and $30,000. For 1999, the maximum amount of compensation which may be considered in this calculation is $160,000 Thus, the maximum allocation to a SEP for an employee is $24,000; for a self-employed individual, the limit is $20,870.1

Time of Contribution: Contributions can be made until the due date (plus extensions) of the employer's return.

Vesting must always be 100%.

Who May Participate: Any employee who is at least 21 years old and has performed "service in at least three of the last five calendar years must be permitted to participate under the SEP unless his or her total compensation is less than $400 for the year.

Investment of Plan Assets: Plan assets can be invested an most equity products or debt instruments but may not be invested in life insurance, "hard" assets or collectibles. (Except for U.S. gold and silver coins.) Participants direct the funds contributed on their behalf.

Withdrawals: Participants may withdraw or cash out at any time. However, withdrawals are included in taxable income in the year received. Withdrawals prior to age 59½ are subject to an additional 10% penalty tax. Exceptions to the 10% penalty apply if a distribution is wade because of the participant's death or disability, or if a distribution is made as a series of "substantially equal periodic" payments over the life expectancy of the SEP owner, or joint life expectancies of the owner and a designated beneficiary. Once the periodic payment format is chosen, it may not be modified without penalty before the later of five years, or the participant reaches age 59½. An additional exception to the 10% penalty applies for distributions made to pay medical expenses in excess of 7.5% of adjusted gross income. In certain cases, distributions to unemployed individuals for payment of health insurance premiums, or withdrawals made to pay certain first-time homebuyer or educational expenses, may also avoid the penalty.

 

Advantages To Employer

  1. Contributions are tax deductible.
  2. Contributions and costs arc totally flexible.
  3. Reporting is very minimal IRS or Dept. of Labor forms.
  4. The plan is easy to understand by the employees.
  5. The plan is easy to set up by merely completing the Model Form 5305-SEP.
  6. There is little or no administrative expense.

Advantages To Employees
  1. Annual contributions are not taxed currently to the participant.
  2. Earnings on the account are not currently taxed.
  3. Participants have the right to direct investments.
  4. Participants may also be able to have a deductible IRA. subject to income level and filing status.
  5. Funds can be withdrawn at any time; as in the event of an emergency such as death or disability. Distributions are includable in taxable income in the year received. A 10% penalty tax may also apply if the participant is under age 59¼ when a distribution is received.

Disadvantages To Employer
  1. Contributions must be made for part-time and seasonal employees.
  2. Employees can withdraw the funds as fast as they are put into the account.
  3. Employees are always 100% vested-there are no forfeitures to reduce employer contributions.
  4. Employees control investments.
  5. Allocation methods which reduce employer costs may not be used.

Disadvantages To Employees

   A.    There is no guarantee as to future benefits.

  B.     Investment risks rest on the participant.

  C.     There is no assurance as to the frequency and amount of employer             contributions.              

  1. Special lump-sum tax treatment of distributions is not available.
  2. There are no forfeitures to be reallocated.
  3. Life insurance funding is not available.
  4. Cannot contribute over the 15% limit (compared to a 25% limit permitted under qualified defined contribution plans).
  5. Bankruptcy protection from creditors is not afforded under Federal law.