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.
