A SEP is a Simplified Employee Pension plan. A SEP provides employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Contributions are made by the employer directly to a Traditional IRA set up for each employee (a SEP-IRA).
- Only employer contributions are made to SEP-IRAs. Employee contributions, such as elective salary deferrals and catch-up contributions are not permitted in SEP plans.
- Employees are always 100% vested in all SEP-IRA money
- Any employee who is at least 21, earns at least $600 per year, and has worked three out of the five preceding years for the employer must be allowed to participate in the employer’s SEP Plan for the current year.
- Any employer may establish an SEP plan. This includes sole proprietorships, partnerships, corporations and non-profit organizations.
- An attractive feature of the SEP plan is that employees may use the same account to which SEP contributions are made for their regular Traditional IRA contributions.
- You may be eligible for a tax credit of up to $500 per year for each of the first 3 years for the cost of starting the plan.
- A SEP-IRA can’t be a Roth IRA.
- Unlike regular contributions to a Traditional IRA, contributions under a SEP can be made to participants over age 70½. If you are self-employed, you can also make contributions under the SEP for yourself even if you are over 70½.
- A SEP-IRA can be self-directed using a Self-Directed SEP-IRA, or SD-SEP-IRA.
- For Checkbook-Control, a SEP-IRA can be combined with a SEP-IRA-LLC or SEP-IRA-Trust to create a Checkbook SEP-IRA.
- A SEP-IRA can be invested in stocks, bonds, mutual funds, real estate, private lending opportunities, cryptocurrency (Bitcoin, Ether, and all other crypto assets), tax-liens & tax-deeds, merchant cash advance, pre-settlement funding, life settlements, crowdfunded assets, and just about anything else.
- A SEP-IRA may not be invested in life insurance or collectibles.
SEP-IRA Detailed Overview
Any employer – including a sole proprietorship, partnership, corporation, and nonprofit organization – may establish a SEP plan. A Traditional IRA that receives SEP-employer contributions is referred to as a SEP IRA and is labeled as such by the custodian financial institution.
A SEP plan allows, but does not require, employers to contribute to Traditional IRAs set up for employees. However, when employers do contribute, all employees that were eligible to participate during the year must receive an allocation, including those that are no longer employed at the time contributions are made.
Employees do not pay taxes on SEP contributions and assets within the plan grow on a tax-deferred basis. Distribution from the plan are taxed as ordinary income. An employee (including the business owner) who is eligible to participate in his or her employer’s SEP plan must establish a Traditional IRA to which the employer will deposit SEP contributions.
SEP Plans that allow for employee salary deferrals, known as Salary Reduction Simplified Employee Pensions (SARSEPs) can no longer be formed. Existing SARSEPS may be grandfathered and continue to operate as such.
SEP-IRA Contribution Limits
Employer contributions for each eligible employee must be:
- Based only on the first $270,000 of compensation for 2017 ($265,000 for 2015 and 2016)
- The same percentage of compensation for every employee
- Limited annually to the smaller of $54,000 for 2017 ($53,000 for 2015 and 2016) or 25% of compensation
- Paid to the employee’s SEP-IRA
Contribution computations for self-employed individuals
When figuring the contribution for your own SEP-IRA, compensation is your net earnings from self-employment, less the following deductions:
- one-half of your self-employment tax and
- contributions to your own SEP-IRA.
For more information on the calculations for self-employed individuals, see IRS Publication 560.
SEP-IRA Contribution Deadline
You can set up and fund a SEP for a year as late as the due date – including extensions – of your business income tax return for the year you want to establish the plan.
Contribution Allocation Formulas
An employer may choose among several formulas to allocate contributions:
- Pro-Rata: Each eligible employee receives the same percentage of his or her eligible compensation.
- Flat-Dollar Formula: Each eligible employee receives the same dollar amount.
- Integration: Higher-paid employees receive a larger percentage of the contribution. The employer designates an overall dollar amount that will be contributed to the SEP. Using specified formulas, the employer then allocates a percentage of the total contribution to each eligible employee.
Tax Deductibility of SEP-IRA Contributions
Contributions made to the plan are tax-deductible to the employer.
SEP-IRA Employee Eligibility Requirements
Generally, any employee who meets all the following requirements must be allowed to participate in the SEP:
- Has reached age 21
- Has worked for the employer in at least 3 of the last 5 years
- Received at least $600 in compensation from the employer during the year (for 2017) in compensation from the employer during the year
Establishing and Operating a SEP-IRA
The employer must follow three basic steps to set up a SEP:
Step 1: Establish the Plan
Complete and sign Form 5305-SEP, a SEP prototype, or individually designed SEP plan document. When it is completed and signed, this form becomes the plan’s basic legal document, describing employees’ rights and benefits.
A SEP may be established as late as the due date (including extensions) of the company’s income tax return for the year the plan is to be established.
Although using the IRS model Form 5305-SEP is the simplest method, there are certain instances in which an employer may not use a Form 5305-SEP:
- The employer currently maintains any other qualified retirement plan other than another SEP.
- The employer has eligible employees for whom SEP IRAs have not been established.
- The employer uses the services of leased employees.
- The employer is a member of an affiliated service group described in Section 414(m) of the IRC, a member of a controlled group of corporations described in Section 414(b) of the IRC, or a member of group of businesses that are under common control described in Section 414(c) of the IRC – and the SEP is not meant to cover all the eligible employees of all the businesses.
Step 2: Communicate the Plan
When employees participate in a SEP, they must receive certain key disclosure documents from you and the custodial financial institution:
- Plan Document
- A written statement containing information about the terms of the SEP, how changes are made to the plan, and when employees are to receive information about contributions to their accounts.
- The custodian financial institution provides an annual statement for each participant’s SEP-IRA, reporting the fair market value of that account and also gives participating employees a copy of the annual statement filed with the IRS containing contribution and fair market value information.
Required Minimum Distributions (RMDs) for SEP-IRAs
As with other Traditional IRAs, participants in a SEP-IRA must begin withdrawing a specific minimum amount from their accounts by April 1 of the year following the year the participant reaches age 70 1/2. For the year following the year in which a participant reaches age 70 1/2, they must withdraw an additional required minimum distribution amount by December 31 of that year and annually thereafter. The financial institution/trustee will notify the participant by January 31 of each year when a minimum distribution is required.