What in the world is a SEP-IRA?

A SEP-IRA, or Simplified Employee Pension Plan IRA, is a retirement plan designed for people who are self-employed or own small businesses. The SEP is the easiest retirement plan for the self-employed taxpayer to maintain. It particularly appeals to small businesses that don't have staffs to handle the extra paperwork and record keeping required by other more complex retirement plans. The contributions are made to a traditional individual retirement account (IRA) of each participant of the plan, hence the term SEP-IRA.

It's simple
The SEP-IRA enrollment process is an easy one. It's generally a two-page application process. The employer completes Form 5305-SEP. The employee completes the IRA investment application usually supplied by a mutual fund company or some other financial institution which will hold the funds. Nothing has to be filed with the IRS to establish the SEP-IRA or subsequently, unlike many other retirement plans that require IRS annual returns.

To establish a SEP-IRA, you must be a sole proprietor, business owner or in a partnership and earn self-employed income by providing a service. The business owner and any eligible employees may establish their own separate SEP-IRA accounts. For tax year 2002, the employer may make tax-deductible contributions of up to 25% of compensation, or $40,000 (whichever is less) per participant, to each employee's SEP-IRA account. No annual contribution is required.

Be careful not to exceed the limits; a non-deductible penalty tax of 6 percent of the excess amount contributed will be incurred for each year in which an excess contribution remains in a SEP-IRA.

It's flexible
Each participant under the SEP may establish his or her own IRA at the institution of his or her choice. As the underlying account is an IRA, any covered employee may have a self-directed IRA as his or her SEP-IRA. This is in addition to any other IRAs one has. Roth IRAs are not eligible for SEPs; however, IRAs to which SEP contributions have been made may be converted to Roth IRAs.

Employees are able to exclude from current income the entire SEP contribution. However, the money contributed to a SEP-IRA belongs to the employee immediately and always. If the employee leaves the company, all retirement contributions go with the employee (this is known as portability). Only employees can contribute to a SEP-IRA. However, employees with SEP-IRAs can also invest in regular IRAs, giving them another opportunity to save for retirement.

The IRS regulations state that employers must include all eligible employees who are at least age 21 and have been with a company for 3 years out of the immediately preceding 5 years. However, employers have the option to establish less-restrictive participation requirements, if desired.

An employer is not required to make contributions in any year or to maintain a certain level of contributions to a SEP-IRA plan. Thus, small employers have the flexibility to change their annual contributions based on the performance of the business.

An investment in the future of our business
When you're starting your own business, establishing a retirement plan for you and your employees may not be a top priority. Like many first-time business owners, you may be focused on survival. But once your business is stable, you may want to reward the employees who helped you get established. Setting up a SEP-IRA is one good way to acknowledge the contributions of your employees.

< Back to Investment Services