[an error occurred while processing this directive] [an error occurred while processing this directive] Simplified Employee Pensions (SEPs)

A simplified employee pension (SEP) is a written arrangement that allows an employer to make contributions toward his or her own and employees' retirement without becoming involved in more complex retirement plans. The contributions are made to special IRAs (SEP-IRA) set up for each individual qualifying employee.

An employer can use IRS Form 5305-SEP to satisfy the written arrangement requirement for a SEP. A SEP can be established at any time during the year. However, contributions to the SEP for a given year must be made by April 15th of the following year.

If you have a SEP plan in place, you don't have to make any contributions to the plan in any given year. But, if you do make contributions for a year, the contributions must be based on a written allocation formula (for example, "2 percent of each employee's pay") and must not discriminate in favor of highly compensated employees.

The SEP rules permit an employer to contribute, and deduct, an annual maximum of 15 percent of the employee's compensation or $30,000, whichever is less, to each participating employee's account. For the business owner, however, the contribution limit is somewhat lower. The business owner's maximum contribution is the net earnings of the business, minus the deduction for one-half the self employment tax, multiplied by a percentage that is somewhat lower than the percentage used to compute the employees' contribution. For example, if your employees were receiving the maximum contribution of 15 percent of pay, you would have to use 13.0435 percent. If your employees receive 10 percent, your percentage would be 9.0909. You can compute your percentage for other rates by taking the employees' rate, expressed as a decimal, and dividing it by that rate plus one.


If the employees' rate was 10.5 percent, you could compute the owner's rate by dividing 0.105 by 1.105 to arrive at .0950, or 9 1/2 percent.

Prior to December 31, 1996 an employer could establish a Salary Reduction Arrangement SEP (SARSEP) under which employees could elect to make contributions out of their own pay, up to a certain dollar limit per year, per employee. This choice is called an elective deferral. IRS Form 5305-SEP is also used to set up this type of arrangement. Although SARSEPs are not permitted to be started after December 31, 1996, you may continue to make contributions to a SARSEP that was established before that date. For 1998 and 1999, the dollar limit for each employee is $10,000.

Distributions or withdrawals from a SEP-IRA are subject to the same rules that apply to regular IRAs.

For more information, see our discussion of SEPs in the context of employee benefits.

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