A SEP IRA is a Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) is a variation of the Individual Retirement Account used in the United States. SEP IRAs are adopted by business owners to provide retirement benefits for the business owners and their employees. There are no significant administration costs for self-employed person with no employees. If the self-employed person does have employees, all employees must receive the same benefits under a SEP plan. Since SEP accounts are treated as IRAs, funds can be invested the same way as any other IRA.
A SEP allows any employer to set up an IRA for themselves and their employees. If desired, participants can be limited to employees who are at least 21 years of age, employed by the employer for 3 of the last 5 years, and who earned $500 or more during the year. There is no hours of service requirement for this type of plan. Employees who meet the other eligibility requirements must be allowed to participate, regardless of the number of hours worked.
Employers must contribute a uniform percentage of pay for each employee who has met the eligibility requirements. The plan has flexible contribution requirements – that is, the employer is not locked into making contributions each year. If your client’s business has fluctuating income, this type of plan gives them flexibility from year to year. However, if contributions are made, they must be allocated to employees based on a written formula and must not discriminate in favor of highly compensated employees.
The maximum employer contribution to a SEP in 2016 is limited to the lesser of 25% of compensation or $53,000. Generally, the employer can deduct the contributions made to the SEP IRAs of his employees, including himself. A self- employed individual’s maximum deduction must be made with a special calculation, which can be complicated. Refer to IRS Publication 560, which includes step-by-step instructions on this calculation. This publication can be viewed at the IRS web site. This calculation essentially reduces the 25% figure to 20% of the self-employed individual self-employment compensation.
In general, the deadline for making SEP contributions is the filing of the employer’s tax return, including extensions.
Employee eligibility conditions may not be any more strict than (i.e. can be less strict):
- be at least 21 years of age
- has worked for the employer for at least three of the previous five years, and
- received at least $500 in compensation for the tax year must be eligible for the employer’s SEP IRA plan.
SEP IRA funds are taxed at ordinary income tax rates when qualified withdrawals are taken after age 59 and a half (the same rule as for traditional IRAs). Contributions to a SEP plan are deductible.