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Simplified Employee Pension (SEP) IRA Accounts

A simplified employee pension plan (SEP) provides the employer with a simple method of establishing a retirement plan for himself and his employees. Each plan participant establishes a SEP IRA into which the employer makes contributions.

ELIGIBILITY

Employer Eligibility

Eligible employers include corporations, partnerships, non-profit organizations, "S" corporations, and sole proprietors (self employed).

Employee Eligibility

An employer can always choose to make all employees eligible to participate in the SEP plan, however the employer is permitted to adopt the following eligibility requirements:
  • Employee must have attained the age of 21 years of age
  • Employee must have performed service during at least three of the five preceding plan years.
For this service requirement, no minimum service is required; even one hour of service is sufficient to meet the year of service requirement

The employer may exclude the following classes of people:
  • Non resident aliens with no U.S. source income
  • Employees who receive retirement benefits as a result of a collective bargaining agreement
  • Employees who earn less than $450 (for 2002) in the plan year.
Universal Coverage Rule

An employer must contribute for all eligible employees in a year in which a contribution is made to the SEP plan, even for those employees who are no longer employed by the employer on the contribution date. This includes the deceased, those whose whereabouts are unknown, and those who failed to establish an IRA by the contribution date.

Affiliated Service Groups

Employers who establish a SEP plan may be required to make a contribution for leased or shared employees. In addition, the employer must consider all groups that are under the common control of the employer.

ESTABLISHING A SEP PLAN

To establish a SEP plan, both the employer and the employee must execute documents.

Employer

An employer may establish and fund a SEP plan up until his due date for filing his tax return, including extensions.

1. The employer must complete the Simplified Employee Pension Plan adoption agreement.

2. The employer must provide a copy of the SEP Plan document and the executed SEP Adoption agreement to all eligible employees.

Employee

3. The employee must establish an IRA account to receive the employer's contributions.

SEP CONTRIBUTIONS

Employer contributions

The employer contribution to a SEP account must be based on a written allocation formula, and must not discriminate in favor of the highly compensated employees. Three contribution allocation formulas are allowable:
  • A uniform dollar amount for all employees
  • A uniform percentage of compensation (not to exceed 25%) for all employees
  • A fixed dollar amount allocated in the ratio that the employees compensation bears to total plan compensation
For purposes of making contributions to a SEP account, compensation is limited to $200,000 (for 2002, subject to COLA's in $5,000 increments).

The annual contribution limit per participant is $40,000 (subject to COLA in $1000 increments).

For common law employees, compensation is considered to be W-2 wages. For self-employed individuals, compensation is earned income.

Plan contributions are subject to top heavy testing.

The employer may change the contribution formula from year to year, or may make no contribution at all for a given year. If the employer does change the contribution allocation formula, however, he must execute a new plan adoption agreement and notify all eligible employees.

Employee contributions

Since the employee's account is an IRA account, the employee may contribute up to the annual IRA contribution limit as a normal IRA contribution. Participation in a SEP plan is considered "active participation" and may affect the deductibility of a regular IRA contribution.

CONTRIBUTION DEDUCTIBILITY
The employer may deduct the amount of his contributions to a SEP plan, not to exceed 25% of total compensation paid to all eligible employees. The employer will take the deduction for the year for which the contributions were made.

SEP DISTRIBUTIONS

Distributions from a SEP account follow all of the rules for distributions from a traditional IRA, except that a participant who is still working and receiving compensation when he attains the age of 70 ½ may continue to make employer contributions to his SEP account. The employee is still subject to the required minimum distribution rules.

SEP EMPLOYEE NOTIFICATION REQUIREMENTS

If the employer offers a prototype SEP, he must provide the following to each eligible employee:

A description of the SEP (the SEP Disclosure).

A statement of the requirements concerning employer contributions to the SEP and the requirements for participation in the SEP (the SEP Adoption Agreement and SEP Plan Document)

An updated IRS Notice 81-1 Questions and Answers

When an employee becomes eligible to participate in the SEP, he must be told that:
  • A SEP plan has been established
  • Who may participate in the plan
  • How employer contributions are calculated
  • Who within the company can answer questions about the SEP
Employees must be notified of employer contributions to the IRA by January 31 following the plan year (for calendar year plans). This requirement is met by providing the customer statement.

If any of the SEP requirements have changed, the employees must be notified within 30 days of the change.

SEP REPORTING REQUIREMENTS

The employer who is sponsoring the SEP is not required to file a Form 5500 with the IRS.

The custodian of the SEP IRA's must report the following:

Fair Market Value Statement
As for traditional IRAs, the custodian must report the fair market value of the IRA account to the participant by January 31.

IRS Form 1099R
The custodian must report all distributions from the SEP IRA to the participant on Form 1099R by January 31.

IRS Form 5498
The custodian must report all contributions to the SEP IRA on Form 5498 by May 31. Contributions to be reported include the SEP employer contributions and the individual's IRA contribution. SEP employer contributions are reported to the IRS in the year in which they are received, regardless of the year for which the employer is taking the deduction.

WHY OFFER A SEP IRA?

Contributions made by the employer are deductible on the employer's tax return.The employer can establish and fund the SEP plan up until his tax filing deadline with extensions. SEP plans do not have a continuity requirement. An employer can fund a SEP plan for one year with no obligation to fund the plan in subsequent years. Allocation of contributions can be flexible but not discriminatory. No 5500 reporting. Fiduciary responsibilities are limited. Contributions are made to the participant's IRA account. The participant directs the investment of the funds. A SEP is a particularly attractive alternative when the owner is the only participant.