Simplified Employee Pension(SEP) or a SEP IRA is a written arrangement that allows an employer to make contributions to a retirement plan for himself and for his employees. Contributions to such plans are tax deductible by the employer.
SEPs allow only employer contributions—there is no provision for employee deferrals as under a 401-K plan or a SAR/SEP plan(new SAR/SEPs can't be established after December 31, 1996). Employer contributions are called non-elective contributions, i.e. the employer makes the contribution and the employee has no choice in the matter.
A SEP plan is not legal until all of the following steps have been completed.
• The employer completes the SEP adoption agreement.
• Traditional IRAs are opened for all eligible employees.
• All employees receive a copy of the SEP adoption agreement.
Completion of the SEP adoption agreement is the responsibility of the employer or the employer’s accountant—most custodians and trustees do not get involved in this step of the process. Two forms options are available:
• The IRS will supply the forms at no cost (Form 5305-SEP).
• The forms can be purchased from one of the form’s vendors.
Individual SEP accounts for the employer and all eligible employees are established by using a traditional account agreement and by coding the accounts as SEP-IRAs.
All qualifying employees must be covered by a SEP plan.
To be a qualifying employee, an individual must meet all of the following requirements:
• The employee must be at least 21 years old.
• The employee must have worked during at least 3 of the 5 years immediately preceding the tax year for which the contribution is to be made.
The employee must have earned at least $550 during the tax year for 2012 and 2013. This amount is adjusted annually for inflation if there is an increase in the cost of living index.
Employers can adopt less restrictive eligibility rules. For example an employer might decide to cover employees who are at least 18 years old and who have 1 year of continuous service.
Some employees can be excluded from the SEP plan. These include:
• Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by their union and their employer.
• Nonresident aliens who had no source of U.S. income from their employer.
Contributions and Deadlines
The limit for SEP contributions is lessor of 25% of compensation, or $50,000 for 2012 and $51,000 for 2013. Compensation is limited to $250,000 for 2012 and $255,000 for 2013. The contribution limit is per year, per employee. The contribution amount will be adjusted for inflation in future years.
The limit for SAR/SEP contributions for 2012 is $17,000 and $17,500 for 2013. Participants who are at least 50 can make additional catch-up contributions of $5,500 for both 2012 and 2013.
Calculations for determining SEP contributions should be made by the employer or the employer’s accountant--this is not the responsibility of the custodian or trustee.
Contributions must be made not later than the due date for filing the employer’s tax return (including extensions).
Other SEP Rules
SEP contributions are excluded from the employee’s income, i.e. they are not reported as taxable income on Form W-2.
Individuals covered by a SEP can also contribute the maximum allowable amount to a traditional or Roth IRA.
The employer cannot place restrictions on the withdrawal of SEP contributions made to an employee’s SEP account.
SEP contributions must be made to traditional accounts, never to Roth accounts.
Once a SEP contribution is made to a traditional account, that amount can be converted to a Roth IRA. The conversion is taxable.
SEPs are considered to be retirement plans for the purpose of the active participation rules and tax deduction rules.
There is no minimum or maximum age restrictions for making SEP contributions.
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