Interested in setting up a retirement plan for yourself and your employees? A simplified employee pension (SEP) plan may be the answer. A SEP plan provides an easy way for you to make contributions to a retirement plan for yourself and your employees. Instead of setting up a profit-sharing or money purchase plan with a trust, you can adopt a SEP agreement and make contributions directly to a traditional individual retirement account or a traditional individual retirement annuity set up for yourself and each eligible employee. The following are some of the advantages of using a SEP:
(1) It 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.
(2) The contributions are tax deductible and your business pays no taxes on the earnings on the investments.
(3) You are not locked into making contributions every year. In fact, you decide each year whether, and how much, to contribute to your employees’ SEP.
(4) Generally, you do not have to file any documents with the government.
(5) SEPs may be set up by sole proprietors, partnerships, and corporations, including S corporations.
(6) You may be eligible for a tax credit of up to $500 per year for each of the first three years for the cost of starting the plan.
(7) Administrative costs are low.
All eligible employees must participate in the plan, including part-time employees, seasonal employees, and employees who die or terminate employment during the year. An eligible employee is an employee who is at least 21 years of age, and has performed service for you in at least three of the last five years.
While your SEP may also cover the following employees, but there is no requirement to cover:
(1) employees covered by a union contract;
(2) nonresident alien employees who did not earn income from you;
(3) employees who received less than a specified dollar amount in compensation during the year ($600 for 2016 and 2017).
An employer may make contributions to an employee’s SEP of up to the lesser of 25 percent of the employee’s compensation or a specified dollar amount ($53,000 for 2016 and $54,000 for 2017).
Employer contributions to an employee’s SEP, up to the contribution limit, are not taxable to the employee. Contributions in excess of the deduction limits are included in the employee’s income for the year and are treated as contributions by the employee to his or her SEP.
Within limits, your company can deduct the contributions it makes to its employees’ SEP. The maximum amount your business can deduct for those contributions is the lesser of:
(1) the contributions (including any excess contributions carryover); or
(2) 25 percent of the compensation paid to the participants during the year from the business that has the plan, not to exceed a specified dollar amount per eligible employee ($53,000 for 2016 and $54,000 for 2017).
The amount of compensation of each eligible employee that the company can take into account in applying the 25 percent limit is capped at a specified dollar amount that is subject to adjustment each year for inflation. The cap is $265,000 per eligible employee for 2016 and $270,000 for 2017.
Participants cannot take loans from their SEP. However, they can make withdrawals at any time. These monies can be rolled over tax free to another SEP, to another traditional IRA, or to another employer’s qualified retirement plan (provided the other plan allows rollovers). Money withdrawn from a SEP (and not rolled over to another plan) is subject to income tax for the year in which an employee receives a distribution. If an employee withdraws money from a SEP before age 59½, a 10 percent additional tax generally applies.
You may establish a SEP as late as the due date (including extensions) of your company’s income tax return for the year you want to establish the plan.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357
P.S. My firm is based upon referrals. Please feel free to refer my firm to anyone you know that is looking for a new CPA and/or tax preparer. Thank you in advance.
(Updated 03/24/2021 08:05)