Simplified Employee Plan (SEP)
A SEP provides an employer with a simplified way to make
contributions to an
employee’s individual retirement account (IRA) or individual retirement
||Employer contributions are made
directly to SEP-IRAs set up for each employee with a bank, insurance company
or other qualified financial institution.|
||Employer contributions are tax
deductible. IRC Sec. 404(h)|
||Contributions are not taxed
currently to the employee. IRC Sec. 402(h)|
Earnings accumulate income
tax-deferred. IRC Sec. 501(a)|
Contributions are vested to the
employee immediately .|
No annual contribution is required. If a contribution is made
and IRS Form 5305-SEP is used as the plan document, the allocation must be
the same percentage for each eligible employee. Allocation formulas which
favor older employees may not be used. If integration with Social Security
is desired, a custom plan or prototype document must be used.
allocation of employer contributions to a participant’s account
may not exceed the lesser of 15% of compensation or $30,000. For the self-employed,
these maximum values are 13.0435% and $30,000. For 2000, the maximum
amount of compensation which may be considered in this calculation is
$170,000. For an
employee, the maximum allocation to a SEP is $25,500; for a self-employed
individual, the maximum allocation to a SEP is also $25,500.
- Time of
Contributions can be made until the due date (plus extensions)
of the employer’s return.
Vesting must always be 100%.
- Who may
employee who is at least 21 years old and has performed
"service" in at least three of the last five calendar years must
be permitted to
participate under the SEP unless his or her total compensation is less
for the year.
- Investment of
Plan assets can be invested in most equity products or debt
instruments but may not be invested in life insurance, "hard"
assets or collectibles.
(Except for U.S. gold and silver coins.) Participants direct the funds
contributed on their behalf.
- Withdrawals: Participants
may withdraw or cash out at any time. However, withdrawals are included in
taxable income in the year received. Withdrawals prior to age 59½ are
subject to an additional 10% penalty tax. Exceptions to the 10% penalty
apply if a distribution is made because of the participant’s death or
disability, or if a distribution is made as a series of "substantially
equal periodic" payments over the life expectancy of the SEP owner, or
joint life expectancies of the owner and a designated beneficiary. Once the
periodic payment format is chosen, it may not be modified without penalty
before the later of five years, or the participant reaches age 59½. An
additional exception to the 10% penalty applies for distributions made to
pay medical expenses in excess of 7.5% of adjusted gross income. In certain
cases, distributions to unemployed individuals for payment of health
insurance premiums, or withdrawals made to pay certain first-time homebuyer
or educational expenses, may also avoid the penalty.
If more than 60% of the plan assets are allocated to "key"
employees, then the employer
must contribute at least as much for "non-key" participants as it
does for key employees. This requirement applies only to a contribution of up
to the first 3% of includable compensation (higher in some instances).
Advantages To Employer
Contributions and costs are totally flexible.
Reporting is very minimal—no IRS or Dept. of Labor forms.
The plan is easy to understand by the employees.
The plan is easy to set up by merely completing IRS Model Form 5305-SEP.
There is little or no administrative expense.
- Contributions are tax deductible.
Advantages To Employees
Earnings on the account are not currently taxed.
Participants have the right to direct investments.
Participants may also have a traditional, deductible IRA (subject to
certain income level limitations based on filing status), a traditional,
nondeductible IRA, or a Roth IRA.
Funds can be withdrawn at any time; e.g., in the event of an emergency
such as death or disability. Distributions are includable in taxable income in
the year received. A 10% penalty tax may also apply if the participant is
under age 59½ when a distribution is received.
- Annual contributions are not taxed currently to the participant.
Disadvantages To Employer
Contributions must be made for part-time and seasonal employees.
Employees can withdraw the funds as fast as they are put into the account.
Employees are always 100% vested—there are no forfeitures to reduce
Employees control investments.
Allocation methods which reduce employer costs may not be used.
Disadvantages To Employees
There is no guarantee as to future benefits.
Investment risks rest on the participant.
There is no assurance as to the frequency and amount of employer
Special lump-sum tax treatment of distributions is not available.
There are no forfeitures to be reallocated.
Life insurance funding is not available.
Cannot contribute over the 15% limit (compared to a 25% limit permitted
under qualified defined contribution plans).
Bankruptcy protection from creditors is not afforded under Federal law.