SEP- Self-Employed Pension

Simplified employee pension (SEP)  plans are commonly used by self-employed individuals and others with part-time self-employment income. In addition, SEPs can offer many benefits to small companies, so business owners may want to consider using a SEP for themselves and the firm’s workers.

On your own

Self-employed individuals choose SEPs for several reasons. 

• There are virtually no costs or paperwork to setting up and maintaining a SEP. 
• Many financial firms offer them, and the investment options are broad. 
• Contribution limits are generous, with a $52,000 maximum for 2014.

 (SEP contributions may be as high as 25% of compensation, but special rules effectively limit contributions to around 20% of your net self-employment income.)

 In addition, SEPs offer a rare opportunity to make retroactive tax deductions. Each year, you can deduct SEP contributions made until the filing date of your tax return, including extensions.

            Example 1: Beth Carson, a freelance graphic artist, qualifies for a $15,000 SEP contribution based on her 2013 earnings. On April 1, 2014, Beth contacts a mutual fund company and creates a SEP, funded with a check for $15,000. As long as Beth makes the contribution by the time she files her 2013 tax return on April 15, she can take a $15,000 tax deduction on that return. If Beth can’t make that deadline, she can request an automatic filing extension until October 15, giving her an extra six months to make a deductible SEP contribution.

Strictly business

Small companies also can use SEPs . Again, the simplicity of such plans, the flexibility, and the high ceiling for contributions may make SEPs appealing to business owners. Employers must fill out and retain IRS Form 5305-SEP to establish the plan, but there are no subsequent required filings with the IRS. The downside is that a SEP is funded entirely by employer contributions; SEPs are different from 401(k)s and similar plans, which are funded largely by employees’ salary deferrals.

 To set up a SEP for your company, you merely have to sign a document with the financial firm you have chosen. Then you must notify each eligible employee about the plan and create an account (a SEP-IRA) for each qualified employee at the financial firm. Once the plan is established, your company must make equivalent contributions for each eligible employee, as a percentage of compensation.

 Example 2: ABC Corp. has two co-owners and four employees. If the owners want maximum SEP contributions of 25% of their pay, the company also must contribute 25% of pay to the SEP-IRAs of the other four employees. (See the Trusted Advice box for guidelines for which employees must be included in a SEP.)

Fortunately, SEP-IRAs are flexible. Even if ABC makes a 25% contribution in a given year, it can make a contribution of any percentage of pay in the following year. The company also can skip contributions altogether, if cash is tight.

 With a SEP, business owners have plenty of time to decide about contribution levels. You can set up and make deductible contributions to a SEP plan as late as the due date (including extensions) of your company’s income tax return for that year. Therefore, your company still has time to set up a SEP plan and make deductible contributions for 2013. 

SEP Requirements

When a company has a SEP plan, it must include all employees who have done all of the following:

o   Reached age 21

o   Worked for the company in at least 3 of the last 5 years

o   Received at least $550 in compensation from your business for the year, subject to annual cost-of-living adjustments in later years

Your company can impose less restrictive requirements, such as reaching age 18 or working there for 3 months.

Certain union members and nonresident aliens may be excluded.