If you want to establish a retirement plan for your business and you missed the last deadline to establish a qualified plan, you may want to consider establishing an SEP. While qualified plans must be established by the end of the plan year (December 31 for plans maintained on a calendar year), SEPs may be established by the business's tax-filing deadline, including extensions. This plan also offers many other attractive features. Here, we review some of these features as well as some factors that you may want to consider before choosing it for your business.

Tutorial: Starting A Small Business

Employer Eligibility and Suitability
An SEP is ideally suited for small businesses and may be established by any business owner, including sole-proprietorships, corporations and partnerships. The SEP is attractive to small businesses because it is easy to establish and administer.

Discretionary Contributions
An employer may decide each year whether to contribute to the SEP. This is an attractive feature for a new business that has not established a trend in its annual earnings. Because of this flexibility, the employer could decide to forgo the SEP contribution in years when profits are less than anticipated.

Contribution Deadline
As with many other employer plans, the employer has until the tax-filing deadline of the business, including extensions, to fund the SEP IRA. Individual employees may use their traditional IRAs to receive their SEP and Traditional IRA contributions.

Deducting SEP Contributions
An employer may deduct up to 25% of eligible compensation paid to employees for the year. For each employee, the maximum amount of compensation that may be considered for 2013 is $255,000. The type of business determines the type of form the employer uses to claim the deduction for SEP contributions.

  • A sole proprietor claims the SEP contribution on behalf of himself/herself on IRS Form 1040; however, SEP contributions on behalf of the sole proprietor's common-law employees are claimed on Schedule C.
  • Partners in a partnership claim deductions for their individual SEP contributions on IRS Form 1040. For contributions made on behalf of common-law employees, the partnership claims the deduction on IRS Form 1065.
  • For an S-corporation, all SEP contributions are claimed on IRS Form 1120S.
  • For a C-corporation, all SEP contributions are claimed on IRS Form 1120-A.

Business owners should consult with their tax professionals to ensure the proper forms are filed to report and claim the deduction for SEP contributions.

Deducting Plan Expenses
A business owner may be eligible to receive a tax credit for expenses incurred when establishing the SEP. The business owner may also be able to deduct plan expenses, including contributions made to the plan. (See Tax Credit for Plan Expenses Incurred by Small Businesses for details.)

Excludable Employees
An employer may exclude the following categories of employees from participating in the SEP for the year:

  • Employees covered under a collective bargaining agreement (unionized employees)
  • Employees who are under age 21
  • Employees who earn less than $550 (indexed for inflation) for the year
  • Employees who worked less than three of the five preceding years
  • Non-resident aliens with no U.S. income
Under ABC Inc.\'s SEP IRA, an individual must work three of the five preceding years in order to be eligible to receive an SEP contribution for the year. Jane worked for ABC Inc. on a part-time basis in 2009, 2010, 2011,and 2012. Assuming Jane meets the other eligibility requirements, she is eligible to receive a contribution for 2013, because she worked for at least three of the five years preceding 2013. For SEP IRAs, a year of service can be any period, however short. This means that an employee who worked for one week in a year is counted as having completed a year of service.

The employer may choose to use less restrictive eligibility requirements in order to allow more employees to participate in the plan.

Minimal Administration
Small business owners find the SEP IRA attractive because of its minimal administrative requirements. Unlike qualified plans, the SEP does not require non-discrimination testing or filing of 5,500 returns. Establishing an SEP IRA can be as easy as completing IRS Form 5305-SEP and providing a copy to employees.

SEP contributions are made to the separate IRAs for eligible employees. Each employee is responsible for establishing his or her own Traditional IRA to receive employer contributions. Unlike employers with qualified plans, the employer of an SEP has no responsibility for providing assistance with investing plan contributions. Individual participants may select their own IRA provider and direct their investments.

Reporting Requirements
For the employer, tax reporting is limited to reporting SEP contributions on the business' tax return. For individual participants, the IRA custodian or trustee reports SEP IRA contributions on IRS Form 5498 and distributions on IRS Form 1099-R. Employers and employees should bear in mind that the custodians report contributions in the year they are received. For instance, if ABC Inc. makes its SEP contributions for 2013 in May of 2014, the Form 5498 may not correspond with the amount the employer reports for 2013. Employers should therefore maintain their own records to keep track of SEP contributions.

Disadvantages of an SEP IRA

Immediate Vesting
To reduce employee turnover and the cost associated with training new employees, some employers like to have employees work for a number of years before the employee is vested in the employer contributions. For SEP IRAs, however, contributions are immediately 100% vested, which means the employee may withdraw the amount immediately after it is deposited into his/her SEP IRA. (For more insight, read How do I "vest" something?)

No Loans Permitted
Unlike qualified plans - under which participants, including the business owner, may borrow up to the lesser of 50% or $50,000 of their vested balance - the SEP, like all IRA-based plans, does not have this feature.

Employee Eligibility Requirements
Under a qualified plan, an employer may require an employee to work at least 1,000 hours in order to accrue one year of service. For an SEP IRA, a year of service is any period, however short. This can result in increased expenses associated with funding the plan, posing a disadvantage especially for businesses that hire part-time or seasonal employees.

Like many small business owners, you may enjoy the simplicity and inexpensive administration of the SEP IRA. While it may be convenient to establish the SEP, you should consult your tax professional to ensure that the plan you choose is suitable for your business profile. If you prefer a qualified plan to an SEP IRA but you missed the deadline to establish a qualified plan, you may fund the SEP and then roll over the balance to the qualified plan that you establish later.

Related Articles
  1. Investing

    10 Surprising Companies That Began as Underdogs

    From fast food to electronics, these success stories give hope to leaders who, despite lacking funds, possess unshakable passion for their underdog brands.
  2. Retirement

    Top 4 Retirement Cities in Uruguay

    With options from a cosmopolitan capital to a South American St. Tropez, the livin' is easy for expats in this coastal neighbor of Argentina and Brazil.
  3. Retirement

    6 Ways to Give Back After Retirement

    Discover the various ways that retired individuals can give back, donating their time, skills and money while still maintaining a comfortable retirement.
  4. Retirement

    Top Retirement Community Developers

    Learn which companies are the top developers of communities for active adults and the history behind each of these popular and well-known companies.
  5. Professionals

    Are ETFs a Good Fit for 401(k) Plans?

    The popularity of ETFs among investors and advisors continues to grow. But are they a good fit for 401(k) plans?
  6. Retirement

    The 5 Best Retirement Communities in Fort Myers, Florida

    Discover why Fort Myers, Florida has become a popular retirement destination, and learn about five of the best retirement communities located in the city.
  7. Retirement

    Using Your 401(k) to Pay Off a Mortgage: The Pros and Cons

    Learn the advantages and drawbacks of using assets accumulated within a 401(k) retirement savings plan to pay down a mortgage balance.
  8. Retirement

    When Annuities Are the Wrong Investment

    Understand how annuities provide several unique benefits, but many drawbacks as well, and identify the situations where they are not the best investment.
  9. Professionals

    RIAs: Why Discounting Your Fees Is a Big Mistake

    For RIAs, lowering your set price is a short-term fix. Here are a few other ways to reach out and appeal to a wider array of potential clients.
  10. Retirement

    Should Retirees Still Have Mortgages?

    Identify the pros and cons of keeping a mortgage into retirement, and understand in which situations it is beneficial not to pay off a mortgage.
  1. What are the main differences between a Simplified Employee Pension (SEP) IRA and ...

    A SEP IRA allows employers a simplified method to contribute toward employees' and their own retirement. A SIMPLE IRA helps ... Read Full Answer >>
  2. How does a Simplified Employee Pension (SEP) plan work?

    Simplified Employee Pension IRAs are a company retirement plan option for small business owners. SEP IRAs are easy to establish ... Read Full Answer >>
  3. What are the main differences between a Simplified Employee Pension (SEP) IRA and ...

    A simplified employee pension IRA is a type of traditional IRA that is designed for self-employed individuals or small business ... Read Full Answer >>
  4. Is a Simplified Employee Pension (SEP) part of the Employee Retirement Income Security ...

    A Simplified Employee Pension (SEP) plan, or any other retirement plan, is a qualified retirement savings plan under the ... Read Full Answer >>
  5. Is a Simplified Employee Pension (SEP) IRA tax deductible?

    Payments that you make to a Simplified Employee Pension (SEP) IRA are tax deductible. However, there is a maximum limit that ... Read Full Answer >>
  6. When are Simplified Employee Pension (SEP) IRA contributions due?

    A SEP IRA, also known as a simplified employee pension plan, is an investment vehicle that allows business owners to contribute ... Read Full Answer >>
  7. How do I set up a 408(k) plan in my business?

    To set up a 408(k) retirement plan, you must first ensure that all eligible employees own an individual IRA account. These ... Read Full Answer >>
  8. What is the difference between a 408 (k) plan and a 401 (k) plan?

    Both 408(k) and 401(k) plans are retirement plans sponsored by an employer. They allow employees to set aside a portion of ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!