SIMPLIFIED EMPLOYEE PENSION PLAN - SEP IRA
A SEP IRA is a retirement account designed for the small business or a self-employed individual who meets the qualifications.
The employer makes tax-deductible contributions to the IRA of all eligible employees.
- Any self employed individual, whether incorporated or not, qualifies to contribute to the SEP-IRA.
- A Larger amount can be contributed to a SEP than to a Traditional or Roth IRA.
- All SEP contributions made on behalf of the employer and employees are 100% tax deductible to the employer.
- Income phase outs do not apply to SEP's, so all contributions are deductible to the employer.
- Contribution percentage may be changed annually.
- The employer may choose to contribute nothing for himself or his employees in any given year.
- Less expensive and easier to manage for employer than other plans because the employee maintains control of his or her individual SEP account.
- An employer can allow employees to have salary deductions deposited directly into a Traditional or Roth IRA.
- Reporting is similar to a traditional IRA. The IRS defines a SEP as a "Traditional IRA" but with higher contribution limits.
- Contributions are based on the employer and employee’s W-2 income or if unincorporated on his/her net income.
- The maximum contribution amounts shown below.
||Maximum Compensation to Base Contribution
|| 25% of $220K
|| 25% of $225K
| 25% of $230K
| 25% of $240K
Covers All Eligible Employees
WHAT ARE THE QUALIFICATIONS?
- Any self employed individual may contribute to a SEP-IRA. Employers do not have to have employees.
In fact, the employer may be the only “employee”.
- If there are employees the employer must contribute for all eligible employees.
Note: It is your responsibility to determine if your plan covers all eligible employees. IRS.
- Eligible employees:
The employer first sets eligibility requirements. The employer must then make contributions for each eligible person who works at the company.
Maximum restrictions (although these can be reduced by the employer):
- Employee must be at least 21 years of age
- Employee is employed any period during three of the last five years (no minimum hours of service required)
- Excludable employees:
The employer can choose up front to exclude certain employees on the 5305-SEP form as follows:
- Employees covered under collective bargaining agreement
- Nonresident aliens
- Employees who earn less than $550 of annual income
- Contributions are required for eligible employees who are over 70 ½ although that person must immediately begin taking distributions.
Employer Contributions Limits
The employer can make annual contributions for himself/herself and eligible employees of 0-25% of compensation, based on the employer and employee’s W-2 income.
If the employer is unincorporated, the employers contribution is then based on his/her net income after the SEP deduction.
The contribution deadline is the employer’s tax filing deadline PLUS EXTENSIONS.
The employer must contribute the exact same percentage of compensation for each employee as he does for himself/herself. There can be no discrimination. An employer may elect to pay 0% for everyone one year, but increase the compensation the next. It doesn't matter as long as everyone in the plan gets the same percentage each year.
Maximum Compensation Allowed To Base SEP Contribution:
See the table (p.1) for the maximum compensation eligible for SEP contributions.
The employer takes all contribution to employee plans as a deduction.
SETTING UP A SEP-IRA
Employer’s Requirements for Establishing the SEP-IRA:
- The employer must supply the employee with a completed form 5305-SEP, which is the IRS approved model plan for establishing SEP-IRAs.
The 5305-SEP requires the employer to state the eligibility requirements (i.e., age, years of service, etc.).
The 5305-SEP provides a written agreement with the employees that the employer will make contributions to the employee’s IRA.
- Once an employee meets the qualifications stated on the 5305-SEP, the employer is required to give a copy to the employee.
The financial institution generally has a template for the employer, but usually does require an executed copy because the agreement is between the employer and the employee.
- An employer may NOT set up a SEP using the IRS model form 5305-SEP if he/she already maintains a qualified plan or has ever maintained a qualified defined benefit plan.
An employer would have to use a prototype (custom plan) approved by the IRS, which integrates the SEP with the OP.
SETTING UP A SEP-IRA (continued)
Employer’s Funding of the SEP-IRA
The employer has several options for funding the SEP-IRA for the benefit of employees:
- If employees have established their SEP-IRA accounts at the financial institution of their choice, the employer will issue a check payable to the financial institution where each SEP account has been established for the employee.
Example: First National Bank Custodian FBO John Smith, SEP-IRA. The employer can mail the check directly to the financial institution or give it to the employee for the employee to deposit into the SEP account at the financial institution of their choice.
- In reality, most employers direct all of their employees to establish their SEP IRA at the same financial institution. This way the employer can send one check to the financial institution with a break down of how much is allocated for each employee.
It is necessary for each employee to set up the Traditional/SEP-IRA at the financial institution before SEP contributions can be contributed.
All SEP contributions made on behalf of the employer and employees are 100% tax deductible to the employer.
The SEP contributions are not affected by the “income phase out” rules of the other IRAs.
SEP participants, both employer and employees, are considered “active participants” of a company sponsored retirement plan if a contribution is made on their behalf for that tax year.
Therefore, contributions to a SEP in a tax year could effect the deduction of a Traditional IRA contribution of the employer and employees if their MAGI is too high for that tax year.
CONTRIBUTIONS TO TRADITIONAL OR ROTH IRAS UNDER THE SEP PLAN
An employer can allow employees to have salary deductions deposited directly into a Traditional or Roth IRA.
This does not affect the amount of the employer contribution. Because the employee is covered by a SEP, it will affect the deductibility of his/her
Traditional contributions depending on the employees MAGI. (See Traditional IRA Education)
VESTING AND WITHDRAWALS
Employees are 100% vested as soon as the contributions are made and may withdraw the funds at anytime from the SEP-IRA. The amount withdrawn will be taxable to the employee.
And, if the employee is under the age of 59 ½, IRS penalties and early withdrawal CD penalties will apply unless the employee meets one of the IRS approved exceptions (discussed in previous modules)
DEADLINE FOR CONTRIBUTIONS
Contributions may be made until the company’s tax return filing due date, plus extensions.
- A participant in a SEP is not subject to “income phase out” rules. That is, the employer may make contributions to any emloyee regardless of income.
- Non Qualified Plan, but . . . SEPs are defined by the IRS as a non-qualified employer plan. However, just like QEPs (Qualified Employer Plans) they affect income limits for participants who want to contribute to a Traditional or Roth on their own. In other words, having a SEP invokes the MAGI income limits that may affect the ability to contribute or take a tax deduction from contributions to a personal IRA that is held separately from the SEP.
Congratulations, you finished!
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