Dec 6, 2009


The simplified employee pension (SEP) is an expanded version of the employer-sponsored IRA, designed by Congress to make it easy and attractive for employers to adopt a retirement plan which, although not a qualified plan as such, has similar features. A SEP is designed much like an employer-sponsored IRA, but the deduction limits are much higher-instead of a $2,000 annual deduction limit, the limit on deductible contributions for each employee is the lesser of $30,000 or 15 percent of the employee's compensation. The price for this expanded deduction limit is that the employer loses discretion as to who must be covered; there is a coverage requirement that in some ways is more stringent than that for regular qualified plans.

Eligibility and Coverage

If the employer has a SEP plan, it must cover all employees who are at least 21 years of age and who have worked for the employer during three out of the preceding five calendar years. Part-time employment counts in determining this; there is no 1,000-hour definition of a year of service. However, contributions need not be made on behalf of employees whose compensation for the calendar year was less than $300 (as indexed for inflation; 2000: $450). The plan can exclude employees who are members of collective bargaining units if retirement benefits have been the subject of good-faith bargaining, and it can also exclude nonresident aliens. Employer contributions to a SEP can be made for employees over age 70½; these employees are not eligible for regular IRAs, as discussed earlier.

Contributions and Deductions

An employer need not contribute any particular amount to a SEP in a given year or even make any contribution at all. In this respect, a SEP is more flexible than any type of qualified plan, even a profit-sharing plan, which requires substantial and recurring employer contributions. However, any employer contribution that is made must be allocated to employees under a definite written formula. The formula may not discriminate in favor of highly compensated employees. In general, the formula must provide allocations as a uniform percentage of total compensation of each employee, taking only the first $150,000 (as indexed for inflation; 2000: $170,000) of compensation into account. The SEP allocation formula can be integrated with Social Security under the usual integration rules for qualified defined-contribution plans.

Each individual in a SEP maintains an IRA and employer contributions to the SEP are channeled to each employee's IRA. For tax purposes, the employer contributions are treated as if they are paid to the employee in cash and included in income and then contributed to the IRA. The Code provides a deduction to both the employer and to the employee for these amounts.

If the employer maintaining a SEP also has a regular qualified plan, contributions to the SEP may reduce the amount that can be deducted for contributions to the regular plan.

Other Requirements

Except for the contribution, allocation, and deduction provisions, the IRAs maintained as part of a SEP are the same as other IRAs and the rules discussed in the previous section apply to them as well. For example, the rules for taxation of distributions from SEP-IRAs are the same as those for other IRAs. As with regular IRAs, loans to participants from SEP-IRAs are not permitted.

Labor and IRS regulations contain certain reporting and disclosure provisions for SEPs. These are simplified if the employer uses the IRS prototype SEP contained on Form 5305-SEP. This form was designed to simplify the adoption of SEPs by employers; however, it uses a nonintegrated formula.

When Should an Employer Use a SEP?

The term simplified in the name of these plans is somewhat misleading; a SEP is not really much simpler than a regular qualified profit-sharing plan, especially where a qualified master or prototype plan is used. However, installation costs are minimal where the government Form 5305-SEP is used; administration costs are low because the annual report form (5500 series) need not be filed. Thus, SEPs are attractive for cases where administrative costs must be absolutely minimized, such as a one-person plan. In other specific situations, the special coverage rules for SEPs may be more attractive than the regular coverage rules. From an employee viewpoint, the complete portability of the SEP benefit is attractive.


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