What is a SEP?
A SEP is a simplified employee pension plan. A SEP plan provides employers with a simplified method to make contributions toward their employees’ retirement and, if self-employed, their own retirement. Contributions are made directly to an Individual Retirement Account or Annuity (IRA) set up for each employee (a SEP-IRA).
Note: The IRS has a system of correction programs for sponsors of retirement plans, including SEPs, which are intended to satisfy Internal Revenue Code requirements but have not met the requirements for a period of time. This system, the Employee Plans Compliance Resolution System (EPCRS), permits employers to correct plan failures and thereby continue to provide their employees with retirement benefits on a tax-favored basis.
How is a SEP established?
A SEP is established by adopting a SEP agreement and having eligible employees establish SEP-IRAs. There are three basic steps in setting up a SEP, all of which must be satisfied.
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A formal written agreement must be executed. This written agreement may be satisfied by adopting an Internal Revenue Service (IRS) model SEP using Form 5305-SEP, Simplified Employee Pension – Individual Retirement Accounts Contribution Agreement. A prototype SEP that was approved by the IRS may also be used. Approved prototype SEPs are offered by banks, insurance companies, and other qualified financial institutions. Finally, an individually designed SEP may be adopted.
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Each eligible employee must be given certain information about the SEP. If the SEP was established using the Form 5305-SEP, the information must include a copy of the Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions. If a prototype SEP or individually designed SEP was used, similar information must be provided.
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A SEP-IRA must be set up for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. The SEP-IRA is owned and controlled by the employee and the employer sends the SEP contributions to the financial institution where the SEP-IRA is maintained.
What types of employers can establish a SEP?
Any employer can establish a SEP.
If an employer has a SEP, can it also have other retirement plans?
An employer can maintain both a SEP and another plan. However, unless the other plan is also a SEP, the employer cannot use Form 5305-SEP; the employer must adopt either a prototype SEP or an individually designed SEP.
If an employee participates in his or her employer’s retirement plan, can he or she set up a SEP for self-employment income?
Yes. A SEP can be set up for a person’s business even if he or she participates in another employer’s retirement plan.
Is there a deadline to set up a SEP?
A SEP can be set up for a year as late as the due date (including extensions) of the business’s income tax return for that year.
How is a SEP plan amended for EGTRRA?
If a prototype plan was used, the employer should have received an amended plan from the financial institution that provided it with the plan. If for some reason the employer didn’t receive a new plan document, the financial institution should be contacted.
While the financial institution provides many administrative services for the plan, it is the responsibility of the employer – the plan sponsor – to ensure that the plan is kept up-to-date with current law.