Article Highlights:
- What Is a SEP?
- Contribution Limits
- Employee Coverage Requirements
- How to Establish a SEP
- SEP Distributions
What is a SEP?
Like many small business owners, you probably find yourself very busy in the wake of the COVID slowdown and are getting back up to speed. But don’t forget about your future.
There are a number of retirement plans available, including Keogh plans and 401(k)s. However, a simplified employee pension plan (SEP) may be your best option.
Contribution Limits
The reason a SEP is “simplified” is that its retirement contributions are deposited into a traditional IRA account under the control of the SEP participant, thus eliminating most of the employer’s administrative duties. That is why these plans are sometimes referred to as SEP-IRAs. SEPs function much like Keogh retirement plans, and they allow tax-deductible contributions for both employees and self-employed individuals. For an employee, the maximum contribution for 2021 is the lesser of 25% of that employee’s compensation or $58,000. These contributions are excluded from the employees’ wages and are not subject to withholding for income tax or FICA. A self-employed person can contribute 25% of his or her compensation after deducting the employer’s contribution, which boils down to the smaller of 20% of the business’ net profit or $58,000. Each year, the employer can specify a compensation amount between zero and 25% (not exceeding the maximums for the year).
SEPs are a great option for startups and other small businesses that have unpredictable income and that may be leery of the long-term contribution matches required with other types of retirement plans. SEPs are also a great option for self-employed individuals with no employees, as the contributions are based upon net profits, allowing the business owner to select the maximum percentage while knowing that the required contribution will be small in low-income years.
Employee Coverage Requirements
Except for when employees are covered by collective bargaining agreements, an employer that elects to make a SEP contribution for the year must contribute to an employee’s SEP-IRA if the employee is at least 21 years of age, has worked for the employer in at least three of the prior five calendar years, and for 2021 has compensation of at least $650. The compensation floor is subject to inflation adjustment annually and had been $600 from 2015 through 2020.
Another advantage of SEP plans is that contributions are allowed after the account owner has reached the age of 72 and must begin taking required minimum distributions from the plan.
As with all traditional IRAs and qualified plans, distributions from a SEP are taxable and subject to a 10% early withdrawal penalty if funds are withdrawn before age 59½.
How to Establish a SEP
A SEP-IRA must be set up by or for each eligible employee, and may be set up with banks, insurance companies or other qualified financial institutions. When setting up a SEP plan, you can adopt the IRS model plan by using Form 5305-SEP or you can adopt whatever plan is offered by the financial institution you’ll be dealing, with, the latter being the better option to ensure that all plan requirements are met. If using a financial institution’s plan, be sure to discuss the plan’s fees.
A SEP can be established and funded up to the due date of the business’ income tax return – even up to the extended due date.
A SEP may be the best option for your business’s retirement plan. Please call this office for more information on how a SEP plan might work for your particular business structure or to determine whether other options should be considered.
