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SEP & SIMPLE IRAs

SEP (Simplified Employee Pension) and SIMPLE (Saving Incentive Match Plan for Employees) are types of Individual Retirement Arrangements (IRAs) available to self-employed individuals and small business owners.

What is SEP & SIMPLE?

Simplified Employee Pension Plan (SEP)

A SEP is a written plan that allows you to make contributions toward your own (if you are self-employed) and your eligible employees' retirement account. In a SEP, you make contributions to Individual Retirement Accounts (IRA's) owned by you or your employee.

In order to participate in the SEP, an eligible employee must meet the following requirements.

  • Be at least 21 years old.
  • Have worked for you in at least 3 of the last 5 years.
  • Has received at least $450 in compensation from you during the year.

To start a SEP plan, you must complete a Form 5305-SEP (PDF) by the due date of your tax return. The form becomes the actual pension plan agreement that you give to your employees. Many financial institutions can help you with this paperwork.

SIMPLE Plans

A Savings Incentive Match Plan for Employees (SIMPLE plan) is a written salary reduction arrangement using Simple IRA's. This arrangement is available if you had no more than 100 employees who earned $5,000 or more in the preceding year. Under this plan, an employee elects to have up to $6,000 of his wages paid directly into a Simple IRA. You deposit the employee's contribution into their Simple IRA account each month.

Each year, you either match your employees' contributions (up to 3% of their pay) or contribute 2% of their pay. However, your contribution does not have to be deposited into their Simple IRA until the due date of your tax return.

Employees can participate in the plan if they:

  • Were paid at least $5,000 in wages in any two prior years, and
  • Are expected to earn at least $5,000 this year.

A self-employed person is also considered and employee. Thus, your contribution to your own plan would be based on your net earnings form self-employment.

The SIMPLE plan can be set up as an individual retirement account (IRA) or an individual retirement annuity. Form 5304-SIMPLE (PDF) (employee selects financial institution) or Form 5305-SIMPLE (PDF) (Employer select the financial institution) make it easier for you to set up the plan and provide the necessary information to your employees. These forms become your written plan, trust document and custodial account document.

Setting Up a SEP

There are three basic steps in setting up a SEP.

  1. You must execute a formal written agreement to provide benefits to all eligible employees.
  2. You must give each eligible employee certain information about the SEP.
  3. A SEP-IRA must be set up by or for each eligible employee.

Many financial institutions will help you set up a SEP.

Formal written agreement. You must execute a formal written agreement to provide benefits to all eligible employees under a SEP. You can satisfy the written agreement requirement by adopting an IRS model SEP using Form 5305-SEP. However, see When not to use Form 5305-SEP, later.

If you adopt an IRS model SEP using Form 5305-SEP, no prior IRS approval or determination letter is required. Keep the original form. Do not file it with the IRS. Also, using Form 5305-SEP will usually relieve you from filing annual retirement plan information returns with the IRS and the Department of Labor. See the Form 5305-SEP instructions for details.

When not to use Form 5305-SEP. You cannot use Form 5305-SEP if any of the following apply.

  1. You currently maintain any other qualified retirement plan. This does not prevent you from maintaining another SEP.
  2. You have any eligible employees for whom IRAs have not been set up.
  3. You use the services of leased employees (as described in chapter 1).
  4. You are a member of any of the following unless all eligible employees of all the members of these groups, trades, or businesses participate under the SEP.
    1. An affiliated service group described in section 414(m).
    2. A controlled group of corporations described in section 414(b).
    3. Trades or businesses under common control described in section 414(c).
  5. You do not pay the cost of the SEP contributions.

Information you must give to employees. You must give each eligible employee a copy of Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions. An IRS model SEP is not considered adopted until you give each employee this information.

Setting up the employee's SEP-IRA. A SEP-IRA must be set up by or for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. You send SEP contributions to the financial institution where the SEP-IRA is maintained. IRS Form 5306-SEP is to be used to apply for approval of Prototype Simplified Employee Pension

Deadline for setting up a SEP. You can set up a SEP for a year as late as the due date (including extensions) of your income tax return for that year

For more details regarding how to choose the right Retirement Plan for your small business see IRS Publication-3998.

 

 

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Last modified: May 09, 2009