In today’s tight job market, employers large and small are in competition to attract and retain top employees with robust employee benefit packages. Many larger businesses find the best approach to meeting their employees’ retirement saving needs is a “qualified” pension or profit-sharing plan. Qualified plans provide an array of features that help employers achieve a range of objectives. However, these plans also involve reporting and record keeping requirements, along with administrative expense.
On the other hand, many smaller businesses don’t need every feature offered by a qualified plan. The most appropriate plan for these employers may be one that delivers an attractive benefit with minimal administration and expense. In addition, if employees would like to defer income, the SIMPLE Individual Retirement Account (IRA) may be a cost-effective solution. However, other smaller companies may want to consider the Simplified Employee Pension (SEP), an equally effective option.
Is a SEP Right for You?
In 1978, Congress created SEPs as an alternative to traditional retirement plans. Rather than setting up a profit-sharing or money purchase plan with a trust, employers can establish a SEP and make contributions directly to a traditional IRA set up for each eligible employee. SEPs provide similar advantages to profit-sharing plans, but since the employee controls the IRA, the employer is not responsible for detailed record keeping and reporting.
While SEPs are usually most appropriate for smaller employers, any business (including C corporations,
S corporations, partnerships, and sole proprietorships) can establish a SEP. Unlike a qualified pension or profit-sharing plan, which must be established no later than the last day of the plan year, an employer can establish a SEP plan up until their tax filing deadline, including extensions.
Establishing a SEP is relatively straightforward. In most cases, the employer completes an IRS Form 5305-SEP, which is used to set the age and service requirements for plan participation, along with the formula for allocating contributions. Once completed, a copy of this document, in addition to other SEP information, is given to each eligible employee to satisfy legal disclosure requirements.
Businesses may establish age or service eligibility requirements for their plans; however, these eligibility requirements may not be more restrictive than those set forth within IRS form 5305-SEP. The employer may exclude all employees covered by a collective bargaining agreement (if retirement benefits were the subject of good faith bargaining), those under age 21, any employees who have not performed services for the employer in at least three of the previous five years, and employees who have received less than $550 in compensation for the current year.
Contributions to a SEP are allocated to eligible employees in proportion to compensation, with each receiving the same percentage of pay. Employer contributions are always 100% vested. These contributions can be substantial, up to the lesser of 25% of an employee’s compensation (limited
to $265,000 or $53,000 in 2016).
Because contributions are discretionary, employers can vary the amount from year to year, or skip the contribution entirely; however, if a contribution is made by the employer in a given year, it must be made for all eligible employees who performed services during the year of the contribution. It is important to note that contributions for self-employed individuals are subject to additional limitations.
If you are a business owner who values simplicity, yet desires a competitive employee benefits
package, a SEP may be an appropriate choice. For more information, be sure to contact your tax and
legal professionals about your unique circumstances.