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Simplified Employee Pensions (SEP-IRA): A Guide for Small Business

Simplified Employee Pensions (SEPs or SEP IRAs) are low-cost retirement plans. Self-employed people and small business owners can use SEPs instead of more expensive retirement savings plans.

SEPs don't have the same startup and operating costs as traditional retirement plans. The annual allowed contributions may differ. Only the employer contributes to a SEP; yearly contributions can vary as the employer desires.

Setting Up Your SEP IRA

The IRS has a convenient step-by-step form to help business owners and sole proprietors set up their SEPs. The disadvantage to using Form 5305-SEP is that you can't use it if you have any other qualified plans, use "leased" employees, or want to include your Social Security contributions in your SEP contributions.

If you can't use Form 5305, financial institutions have prototype forms you can use to create your own SEP-IRA account. You need a qualified financial institution to act as trustee for your SEP. Banks, insurance companies, credit unions, and brokerage firms can handle your company's SEPs.

Each eligible employee must have a SEP. A SEP IRA vests immediately.

Eligibility Requirements

Employee eligibility requirements apply to anyone wishing to take part in a SEP plan, including self-employed people and sole proprietors. To take part, an employee must meet these requirements:

  • Be at least 21 years old
  • Have worked for the employer at least three of the last five years
  • Have received at least $750 in compensation for 2022

The minimum required compensation changes annually. Employers should consult their financial advisors or check the IRS SEP guidance when setting up their SEP plan.

Your participation requirements can be less restrictive than those of the IRS, but not more. For instance, if your employees can take part immediately after hiring, you may do that. You can't force them to wait 10 years before participation.

All employees are generally eligible for SEP plans if they are available. You can exclude some employees from your SEP, which relates to:

  • Employees with a union or collective bargaining agreement with previously determined retirement benefits
  • Nonresident alien workers whose wages are not subject to U.S. taxes

Contributing to Employee SEP Plans

Employers make 100% of the employee SEP IRA contribution. The employee does not make any contributions to the SEP.

There are annual contribution limits for SEPs. Employers are limited to:

  • 25% of the employee's salary or
  • $69,000 for the 2024 calendar year (the maximum contribution changes annually)

Unlike the older SARSEP plan, catch-up contributions (contributions above the minimum annual amount) are not allowed in SEP IRA accounts.

You must correct and report contributions above the allowable annual amount to the IRS. Use IRS Form 1099 to reallocate the over-allocated sum.

Maintaining a SEP Plan

All eligible employees must get written notice of the SEP and instructions on getting their allocation before your plan activates. The notice must tell the employees:

  • That you are adopting the SEP, and the location of the financial institution
  • A statement that other IRAs may provide different terms and rates of return
  • A statement that the SEP administrator (usually the financial institution) will provide participants with copies of any amendments or changes within 30 days of the effective date
  • Notice that the administrator will notify the participants of employer contributions by Jan. 31 of the following year

Each eligible employee must have a separate SEP IRA. The employee manages their own investment options for the IRA. The employee can make the required minimum distribution requests from the institution.

Advantages of a SEP IRA Plan

The employee benefits of a SEP resemble a traditional IRA or 401(k) plan. There are no income tax costs while the SEP accumulates. Employees can withdraw from their SEP whenever they like, although the IRS levies taxes on that sum.

Employers enjoy lower startup costs and minimal administrative expenses. The financial institution may do most of the work.

Contributions are tax-deductible, and tax benefits can be back-dated if made by the due date of your tax returns. You don't have to wait until next year for you and your employees to start their SEP IRA.

You decide how much you will contribute in any calendar year. You are not locked into a contribution amount if your income does not permit contributions for one year.

Like other employee compensation plans, SEP IRAs can roll over to different financial institutions if the worker leaves the company.

Get Legal Help Setting up Your SEP IRAs

Small business owners, partnerships, and sole proprietors have much to do. But you want you and your employees to have a retirement plan that your company can afford. Talk to a business law attorney in your area to ensure your simplified employee pension plan works correctly.

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