SEP IRAs and SEP Plans

Congress made it easy for the self-employed and small business owners to save for retirement with the
Simplified Employee Pension (SEPpronounced sep) plan.  A SEP allows an individual to put up to $40,000 a year, tax deductible, into his or her retirement account.

When an economy is going through a shakeout like ours has these past three years, large businesses lay off talented employees who in turn start their own small businesses.  Once covered by corporate retirement plans, these ex-employees must now fend for themselves when it comes to retirement savings.

With a SEP plan, the employer or the self-employed individual contributes directly to the employees IRA account.  Participants do not need a separate SEP account if they already have an established IRA.

Unlike the more common profit sharing or 401k plans, the SEP does not require complicated documentation, administration or annual tax reporting, relieving the employer of the expenses of a normal pension plan.

SEPs are available for the self-employed (including anyone with a part-time business), sole proprietorships, S and C corporations and partnerships.

An employer can contribute up to 25% of an employees annual compensation, not to exceed $40,000.  In the case of self-employed individuals, compensation is considered to be income reported on schedule C of their tax returns.  Direct employer contributions to a SEP are not subject to Social Security (FICA) or Federal Unemployment (FUTA) taxes.

An employer-sponsored SEP plan cannot discriminate between employees.  Contribution percentages must be uniform in their relationship to the compensation of each employee.  In cases where there is a large disparity in compensation, a SEP plan may be integrated with a Social Security wage base.  This will allow workers who make more than the wage base to end up with a larger contribution.

Annual contributions by an employer are not mandatory and can be made when desired.  All of the contributions go into the participants IRA, and the participant is immediately 100% vested in the contribution.  This allows participants complete control over the investments, just as they would have in a regular participant IRA.

A SEP participant may purchase any investment allowed in an IRA.  Unlike qualified pension plans that limit in-service withdrawals, a SEP allows the owners the right to withdraw the money immediately, subject to taxes and early withdrawal penalties.  They may also convert the IRA into a Roth IRA, paying taxes for the amount converted.

Withdrawals from a SEP are taxed just like an IRA, with participants paying ordinary income taxes plus a 10% penalty if distributions are taken before age 59 .  While loans are not permitted from a SEP, the account owner may make a qualified 60-day withdrawal and rollover once each year without incurring taxation or interest charges.

Employers wishing to set up a SEP for this year do not have to complete paperwork or make the contribution until they file their 2003 taxes (plus any extensions).  Another important feature for employers contemplating establishment of a SEP is that employees do not have to be covered by the plan until they have worked three years.  Employees covered by collective bargaining agreements and non-resident aliens are also exempt from coverage.

SEPs are an ideal pension savings plan for smaller businesses (generally with around 10 or fewer employees) because of the flexibility afforded the employer in timing and amounts of contribution, ease of use, reduced administration expenses and the fact that there is no limit to the number of employees that a SEP plan may cover.

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