If you are a self employed or a small business owner then chances are you will find it difficult to set up a retirement plan for yourself and your employees. Traditional contribution plans are not as flexible and are often costly. If you are a small business with cyclical revenue streams then a traditional retirement plan might be a cash flow nightmare. If you are a small business owner but want to set money aside for yourself and your employees then a Simplified Employee Pension Plan could be the best solution for you.
What Is An SEP Plan?
A Simplified Employee Pension (SEP) plan is a retirement plan established by employers, including self-employed individuals. SEP plans can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee’s pay.
Who May Establish An SEP Plan?
Sole proprietors, partnerships, corporations, and nonprofit organizations with one or more employees may establish an SEP plan. Even if you are a self-employed business owner, regardless of whether you are the only employee of the business, you too can establish an SEP plan. However, individual employees can’t establish an SEP plan; instead, individual employees, who are eligible to participate in a SEP plan, must establish their own individual Traditional IRA to which the employer will deposit SEP contributions. Generally, a Traditional IRA that receives SEP-employer contributions is referred to as an SEP IRA and is labeled as such by the financial institution.
Why Establish An SEP Plan?
The main reason employers choose to setup an SEP plan is the low start-up and maintenance cost. Another advantage of an SEP plan is the flexibility of employer contributions; since contributions are discretionary, employers decide if they will fund the SEP for that year. This works great for employers who want to give bonuses based on annual profits in the form of retirement contributions. Even more so, the contributions are tax deductible. The most you can deduct on your business’s tax return for contributions to your employees’ SEP-IRAs is the lesser of your contributions or 25% of compensation. The max contribution for 2017 is $54,000 ($53,000 for 2015 and 2016) and contributions to employees’ SEP-IRAs are not included in their gross income.
A SEP-IRA is a traditional IRA for tax purposes. Therefore, SEP-IRAs can hold contributions made by an employer under a SEP plan and can receive employer contributions. Employees can contribute to a SEP-IRA and make regular, annual contributions to a traditional or Roth IRA. However, Because a SEP-IRA is a traditional IRA, you may be able to make regular, annual IRA contributions to this IRA, rather than opening a separate IRA account. Employer contributions made under a SEP plan do not affect the amount you can contribute to an IRA on your own behalf. However, any dollars you contribute to the SEP-IRA will reduce the amount you can contribute to other IRAs, including Roth IRAs, for the year.
Because the funding vehicle for an SEP is a Traditional IRA, the distributions rules of a Traditional IRA apply. Distributions that occur before the age of 59.5 are subject to a 10% early-distribution penalty, in addition to any income tax; waivers apply for the early-distribution penalty if distributions are used for specified reasons. Distributions that occur on or after the age 59.5 may be subject to income tax but will not be subjected to the 10% early-distribution penalty. Lastly, IRA distributions cannot be deferred indefinitely; an IRA owner must begin required minimum distributions (RMDs) the year he or she reaches age 70.5, at which time the IRA owner may distribute the full balance of the IRA or distribute a minimum amount each year.
For any small business owner or self employed individual who wants to save for retirement, an SEP plan might be a perfect fit. An SEP plan is easy to establish, affordable to maintain, and flexible when it comes to contributions. SEP plans are similar to Traditional IRAs and is a great alternative 401k matching plans. If you have questions on your specific financial position and whether or not an SEP plan is right for you consult your CPA or financial adviser.