SEP—Simplified Employee Pension Plan

The SEP offers owners of small- and medium-sized businesses an opportunity to save for retirement with the simplest retirement plan available today. The business contributes directly to a special SEP-IRA account for the owner and each eligible employee. A SEP is appropriate for sole proprietors, partnerships, and corporations.

Easy to Establish
A pre-approved IRS Form and IRA application for each participant.

Easy to Maintain
No initial or annual government filings.

Inexpensive
IRA fee of $15 paid by each participant.

Contributions are made by the business for the owner and each employee who is 21 years or older and has worked at least 3 of the last 5 years (including part-time). Lesser requirements may be chosen. Deductible contributions are made in the same percentage (up to 15 percent) of each eligible employee's compensation but no one can receive more than $25,500. SEP contributions are always 100 percent vested.

SEP plans. SEPs provide a simplified method for you to make contributions to a retirement plan for your employees. Instead of setting up a profit-sharing or money purchase plan with a trust, you can adopt a SEP agreement and make contributions directly to a traditional individual retirement account or a traditional individual retirement annuity (SEP-IRA) set up for each eligible employee.

SIMPLE plans. A SIMPLE plan can be set up by an employer who had 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding calendar year and who meets certain other requirements. Under a SIMPLE plan, employees can choose to make salary reduction contributions rather than receiving these amounts as part of their regular pay. In addition, you will contribute matching or nonelective contributions. The two types of SIMPLE plans are the SIMPLE IRA plan and the SIMPLE 401(k) plan.

Qualified plans. The qualified plan rules are more complex than the SEP plan and SIMPLE plan rules. However, there are advantages to qualified plans, such as increased flexibility in designing plans and increased contribution and deduction limits in some cases.

Important Changes for 2002

Increase in limits on elective deferrals under a SEP-IRA. In general, the limit on elective deferrals made on your behalf for 2002 that represent a reduction in your salary under a SEP-IRA cannot be more than $11,000 (up from $10,500 for 2001). For more information, see What Is a Salary Reduction Arrangement, in this chapter.

Increase in overall limits on SEP-IRA contributions. For 2002, your employer can contribute to your SEP-IRA up to the lesser of 15% of your compensation or $30,000 (up from $25,500 in 2001). For more information, see What Is a Salary Reduction Arrangement, in this chapter.

Additional elective deferrals under a SEP-IRA for persons 50 and older. For contributions made after December 31, 2001, additional elective deferrals can be contributed to your salary reduction arrangement SEP-IRA if:

• You are 50 or older, and
• No other elective deferrals can be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

See What Is a Salary Reduction Arrangement, in this chapter.

Credit for salary reduction contributions. For tax years beginning after December 31, 2001, if you are an eligible individual, you may be able to claim a credit for a percentage of your qualified retirement savings contributions, such as salary reduction contributions to your SEP. To be eligible, you must be at least 18 years old as of the end of the year, and you cannot be a student or an individual for whom someone else claims a personal exemption. Also, your adjusted gross income (AGI) must be below a certain amount. Adjusted gross income is the amount from your Form 1040 line 33 or Form 1040A line 19.

Defined - What is a SEP?

A SEP-IRA, or Simplified Employee Pension IRA, is a tax-deferred retirement plan provided by sole proprietors or small businesses, most of which do not have any other retirement plan. Contributions are made by the employer, up to 15% of each employee's total compensation, with a maximum contribution of $25,500. With the exception of the higher contribution limits, they are subject to the same rules as a regular IRA.

In a SEP-IRA, contributions and the investment earnings can grow tax-deferred until withdrawal (assumed to be retirement), at which time they are taxed as ordinary income.

A simplified employee pension (SEP) is a written plan that allows you to make contributions toward your own retirement (if you are self-employed) and your employees' retirement without getting involved in a more complex qualified plan.

Under a SEP, you make the contributions to a traditional individual retirement arrangement (called a SEP-IRA) set up by or for each eligible employee. A SEP-IRA is owned and controlled by the employee, and you make contributions to the financial institution where the SEP-IRA is maintained.

SEP-IRAs are set up for, at a minimum, each eligible employee (defined later). A SEP-IRA may have to be set up for a leased employee (defined in chapter 1), but does not need to be set up for excludable employees (defined later).

Costs

Covering employees

All employees must be covered.  The employer must make contributions on behalf of each eligible employee and cannot discriminate.

Setup costs

Setting Up a SEP

There are three basic steps in setting up a SEP:

1. You must execute a formal written agreement to provide benefits to all eligible employees.
2. You must give each eligible employee certain information about the SEP.
3. A SEP-IRA must be set up by or for each eligible employee.

The cost of the setup will be negligible - there will be no charge for preparing any plan as model or prototype plans are available.  Plan Custodians may charge a small fee for the initial opening of the plan and an annual maintenance fee.  These costs are usually very reasonable and usually comparable to the IRA maintenance fee.

Bob Parrish CPA,  will help you set up a SEP

Formal written agreement. You must execute a formal written agreement to provide benefits to all eligible employees under a SEP. You can satisfy the written agreement requirement by adopting an IRS model SEP using Form 5305-SEP. However, see When not to use Form 5305-SEP, later.

If you adopt an IRS model SEP using Form 5305-SEP, no prior IRS approval or determination letter is required. Keep the original form. Do not file it with the IRS. Also, using Form 5305-SEP will usually relieve you from filing annual retirement plan information returns with the IRS and the Department of Labor. See the Form 5305-SEP instructions for details.

When not to use Form 5305-SEP. You cannot use Form 5305-SEP if any of the following apply.

1. You currently maintain any other qualified retirement plan. This does not prevent you from maintaining another SEP.
2. You have any eligible employees for whom IRAs have not been set up.
3. You use the services of leased employees (as described in chapter 1).
4. You are a member of any of the following unless all eligible employees of all the members of these groups, trades, or businesses participate under the SEP.
   1. An affiliated service group described in section 414(m).
   2. A controlled group of corporations described in section 414(b).
   3. Trades or businesses under common control described in section 414(c).
5. You do not pay the cost of the SEP contributions.

Information you must give to employees. You must give each eligible employee a copy of Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions. An IRS model SEP is not considered adopted until you give each employee this information.

Setting up the employee's SEP-IRA. A SEP-IRA must be set up by or for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. You send SEP contributions to the financial institution where the SEP-IRA is maintained.

Deadline for setting up a SEP. You can set up a SEP for a year as late as the due date (including extensions) of your income tax return for that year.

 

Annual maintenance and tax filing

Reporting and Disclosure Requirements

If you set up a SEP using Form 5305-SEP, you must give your eligible employees certain information about the SEP when you set it up. See Setting Up a SEP, earlier. Also, you must give your eligible employees a statement each year showing any contributions to their SEP-IRAs. You must also give them notice of any excess contributions. For details about other information you must give them, see the instructions for Form 5305-SEP or 5305A-SEP (for a salary reduction SEP).

Even if you did not use Form 5305-SEP or Form 5305A-SEP to set up your SEP, you must give your employees information similar to that described above. For more information, see the instructions for either Form 5305-SEP or Form 5305A-SEP.

Contributions

Requirements for annual contributions

There is no requirement for the employer / self-employed to make a contribution once the plan is established.  The percentage can be changed from one year to the next, including not making any amount in a year.  There is a requirement that if the owner makes a contribution - all eligible employees must be funded with an identical rate.

Employees

Eligible employees

An eligible employee is an individual who meets all the following requirements.

• Has reached age 21.
• Has worked for you in at least 3 of the last 5 years.
• Has received at least $450 in compensation from you for 2001.

Excludible employees

The following employees can be excluded from coverage under a SEP.

• Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and you.
• Nonresident alien employees who have received no U.S. source wages, salaries, or other personal services compensation from you. For more information about nonresident aliens, see Publication 519, U.S. Tax Guide for Aliens.

Contribution Limits

How Much Can I Contribute?

The SEP rules permit you to contribute a limited amount of money each year to each employee's SEP-IRA. If you are self-employed, you can contribute to your own SEP-IRA. Contributions must be in the form of money (cash, check, or money order). You cannot contribute property. However, participants may be able to transfer or roll over certain property from one retirement plan to another. See Publication 590 for more information about rollovers.

You do not have to make contributions every year. But if you make contributions, they must be based on a written allocation formula and must not discriminate in favor of highly compensated employees (defined in chapter 1). When you contribute, you must contribute to the SEP-IRAs of all participants who actually performed personal services during the year for which the contributions are made, even employees who die or terminate employment before the contributions are made.

The contributions you make under a SEP are treated as if made to a qualified pension, stock bonus, profit-sharing, or annuity plan. Consequently, contributions are deductible within limits, as discussed later, and generally are not taxable to the plan participants.

A SEP-IRA cannot be designated as a Roth IRA. Employer contributions to a SEP-IRA will not affect the amount an individual can contribute to a Roth IRA.

Contribution Limits Examples

Contributions you make for 2001(Caution: See changes for 2002 and later and the Related Articles) to a common-law employee's SEP-IRA cannot exceed the lesser of 15% of the employee's compensation or $35,000 ($40,000 for 2002). Compensation generally does not include your contributions to the SEP. However, if you have a salary reduction arrangement, see Employee compensation under Salary Reduction Simplified Employee Pension (SARSEP), later.

Example. Your employee, Mary Plant, earned $21,000 for 2001. The maximum contribution you can make to her SEP-IRA is $3,150 (15% x $21,000).

Contributions for yourself. The annual limits on your contributions to a common-law employee's SEP-IRA also apply to contributions you make to your own SEP-IRA. However, special rules apply when figuring your maximum deductible contribution. See Deduction Limit for Self-Employed Individuals, later.

Annual compensation limit. You cannot consider the part of an employee's compensation over $170,000 when figuring your contribution limit for that employee. Therefore, $25,500 is the maximum contribution for an eligible employee whose compensation is $170,000 or more. (The annual compensation limit increases to $200,000 for 2002.)

More than one plan. If you contribute to a defined contribution plan (defined in chapter 4), annual additions to an account are limited to the lesser of $35,000 or 25% of the participant's compensation. (For 2002, annual additions are limited to the lesser of $40,000 or 100% of the participant's compensation.) When you figure this limit, you must add your contributions to all defined contribution plans. Because a SEP is considered a defined contribution plan for this limit, your contributions to a SEP must be added to your contributions to other defined contribution plans.

Tax treatment of excess contributions. Excess contributions are your contributions to an employee's SEP-IRA (or to your own SEP-IRA) for 2001 that exceed the lesser of the following amounts.

• 15% of the employee's compensation (or, for you, 13.0435% of your net earnings from self-employment).
• $35,000 ($40,000 for 2002).

Non-discrimination

There is a requirement that if the owner makes a contribution - all eligible employees must be funded with an identical rate.

Vesting

Each employee must be fully vested immediately upon funding.

Time limit for making contributions

To deduct contributions for a year, you must make the contributions by the due date (including extensions) of your tax return for the year.

Reporting on Form W-2

Do not include SEP contributions on your employee's Form W-2 unless contributions were made under a salary reduction arrangement (discussed later).

Deductions

Deducting Contributions

Generally, you can deduct the contributions you make each year to each employee's SEP-IRA. If you are self-employed, you can deduct the contributions you make each year to your own SEP-IRA.

Deduction Limit for Contributions for Participants

The most you can deduct for your contributions for participants is the lesser of the following amounts.

1. Your contributions (including any elective deferrals and excess contributions
   carryover).
2. 15% of the compensation (limited to $170,000 per participant) paid to them during 2001 from the business that has the plan.

Deduction Limit for Self-Employed Individuals

If you contribute to your own SEP-IRA, you must make a special computation to figure your maximum deduction for these contributions. When figuring the deduction for contributions made to your own SEP-IRA, compensation is your net earnings from self-employment (defined in chapter 1), which takes into account both the following deductions.

• The deduction for one-half of your self-employment tax.
• The deduction for contributions to your own SEP-IRA.

The deduction for contributions to your own SEP-IRA and your net earnings depend on each other. For this reason, you determine the deduction for contributions to your own SEP-IRA indirectly by reducing the contribution rate called for in your plan. To do this, use the Rate Table for Self-Employed or the Rate Worksheet for Self-Employed, whichever is appropriate for your plan's contribution rate, in chapter 5. Then figure your maximum deduction by using the Deduction Worksheet for Self-Employed in chapter 5.

Deduction Limits for Multiple Plans

For the deduction limits, treat all your qualified defined contribution plans as a single plan and all your qualified defined benefit plans as a single plan. See Kinds of Plans in chapter 4 for the definitions of defined contribution plans and defined benefit plans. If you have both kinds of plans, a SEP is treated as a separate profit-sharing (defined contribution) plan. A qualified plan is a plan that meets the requirements discussed under Qualification Rules in chapter 4. For information about the special deduction limits, see Deduction limit for multiple plans under Employer Deduction in chapter 4.

SEP and profit-sharing plan. If you also contribute to a qualified profit-sharing plan, you must reduce the 15% deduction limit for that profit-sharing plan by the allowable deduction for contributions to the SEP-IRAs of those participating in both the SEP plan and the profit-sharing plan.

Carryover of Excess SEP Contributions

If you made SEP contributions that are more than the deduction limit (nondeductible contributions), you can carry over and deduct the difference in later years. However, the carryover, when combined with the contribution for the later year, is subject to the deduction limit for that year. If you also contributed to a defined benefit plan or defined contribution plan, see Carryover of Excess Contributions under Employer Deduction in chapter 4 for the carryover limit.

Excise tax. If you made nondeductible (excess) contributions to a SEP, you may be subject to a 10% excise tax. For information about the excise tax, see Excise Tax for Nondeductible (Excess) Contributions under Employer Deduction in chapter 4.

When To Deduct Contributions

When you can deduct contributions made for a year depends on the tax year on which the SEP is maintained.

• If the SEP is maintained on a calendar year basis, you deduct contributions made for a year on your tax return for the year with or within which the calendar year ends.
• If you file your tax return and maintain the SEP using a fiscal year or short tax year, you deduct contributions made for a year on your tax return for that year.

Example. You are a fiscal year taxpayer whose tax year ends June 30. You maintain a SEP on a calendar year basis. You deduct SEP contributions made for calendar year 2001 on your tax return for your tax year ending June 30, 2002.

Where To Deduct Contributions

Deduct contributions for yourself on line 29 of Form 1040. You deduct contributions for your employees on Schedule C (Form 1040), Profit or Loss From Business, on Schedule F (Form 1040), Profit or Loss From Farming, on Form 1065, U.S. Return of Partnership Income, on Form 1120, U.S. Corporation Income Tax Return, on Form 1120-A, U.S. Corporation Short-Form Income Tax Return, or on Form 1120S, U.S. Income Tax Return for an S Corporation, whichever applies to you.

If you are a partner, the partnership passes its deduction to you for the contributions it made for you. The partnership will report these contributions on Schedule K-1 (Form 1065), Partner's Share of Income, Credits, Deductions, etc. You deduct the contributions on line 29 of Form 1040.

If the plan contri- Your

bution rate is: rate is:

(shown as %) (shown as decimal)

1 . . . . . . . . . . . . . . .009901

2 . . . . . . . . . . . . . . .019608

3 . . . . . . . . . . . . . . .029126

4 . . . . . . . . . . . . . . .038462

5 . . . . . . . . . . . . . . .047619

6 . . . . . . . . . . . . . . .056604

7 . . . . . . . . . . . . . . .065421

8 . . . . . . . . . . . . . . .074074

9 . . . . . . . . . . . . . . .082569

10 . . . . . . . . . . . . . .090909

11 . . . . . . . . . . . . . .099099

12 . . . . . . . . . . . . . .107143

13 . . . . . . . . . . . . . .115044

14 . . . . . . . . . . . . . .122807

15* . . . . . . . . . . . . . .130435*

16 . . . . . . . . . . . . . .137931

17 . . . . . . . . . . . . . .145299

18 . . . . . . . . . . . . . .152542

19 . . . . . . . . . . . . . .159664

20 . . . . . . . . . . . . . .166667

21 . . . . . . . . . . . . . .173554

22 . . . . . . . . . . . . . .180328

23 . . . . . . . . . . . . . .186992

24 . . . . . . . . . . . . . .193548

25* . . . . . . . . . . . . . .200000*

The deduction for annual employer contributions to a SEP plan or a profit-sharing plan cannot be more than 13.0435% of your net earnings (figured without deducting contributions for yourself) from the business that has the plan. If the plan is a money transacpurchase pension plan, the deduction is limited to 20% of your net earnings.

1) Plan contribution rate as a decimal _____________

(for example, 101/2% = 0.105) . . . .

2) Rate in line 1 plus 1 (for example, ______________

0.105 + 1 = 1.105) . . . . . . . . . . .

3) Self-employed rate as a decimal _______________

rounded to at least 3 decimal places