SEP IRAs: Contributions
By Denise Appleby
SEP contributions are made on a discretionary basis, which means the employer decides each year whether to make an SEP contribution for eligible employees; furthermore, SEP contributions in excess of certain limits must be corrected in accordance with regulatory requirements in order to avoid penalties. The requirements vary depending on the type of excess contribution. Employers who make excess SEP contributions should consult with their SEP providers or a tax professional regarding corrective measures.
An employer may contribute up to 25% of the eligible employee's compensation, provided the contribution does not exceed $51,000 (indexed). The employee's compensation in excess of the compensation cap, which is $255,000 (indexed), is not used to determine the contribution limit - the compensation cap is the maximum compensation that may be considered for employer-plan purposes.
For contributions made to the plan, the employer will be eligible to receive a tax deduction within established regulatory limits.
The following example illustrates how the contribution limits apply:
Example: SEP IRA Contribution Limits
For the 2013 tax year, XYZ Corporation decided to make a 25% contribution for each eligible employee. These employees receive W-2 wages in the following amounts:
An employer may chose among several formulas to allocate contributions:
With this formula, each eligible employee receives the same percentage of his or her eligible compensation. The pro-rata formula is demonstrated in the example above with XYZ Corporation.
With this formula, each eligible employee receives the same dollar amount as a contribution.
Social Security Integration
Here, higher-paid employees receive a larger percentage of the contribution. With this formula, the employer assigns an amount that is a percentage of the accumulated total of all eligible employees' compensation to the SEP plan. Using a special formula, the employer then allocates a contribution percentage to each eligible employee. The allocation must be done according to specific regulatory requirements otherwise, the SEP may be disqualified.
Example: Using the Social Security Integration Formula
For the employees and the figures in the example above, XYZ determines that the total contribution to the SEP plan will be $110,000. Instead of allocating 25% to each employee, XYZ decides to allocate the $110,000 among the employees using the Social Security integration formula. As a result, higher paid employees will receive a higher percent (based on eligible compensation) than lower-paid employees.
All three formulas meet IRS requirements.
SEP employer contributions must be made to each employee's SEP IRA by the employer's tax-filing deadline (including extensions).
Salary-Deferral SEPs (SARSEPs)
Salary-deferral SEPs allow eligible employees to make salary-deferral contributions to their SEP IRAs, which means employees can elect to defer receiving a portion of their compensation so that it will be contributed to their SEP IRA. These contributions are made on a pretax basis. In addition to these salary-deferral contributions, the employer may also make SEP (employer) contributions to each eligible employee's SEP IRA.
Effective for tax years beginning January 1, 1997, SARSEPs can no longer be established. Employers that established SARSEPs prior to January 1, 1997, are allowed to continue maintaining these plans.
SARSEP Employer Eligibility Requirement
An employer is eligible to maintain a SARSEP only if the employer meets the following requirements:
- At least 50% of employees eligible to participate in the SEP plan chose to participate in the salary-deferral arrangement.
- The employer has 25 or fewer employees who are eligible to participate in the SEP at any time during the preceding year.
- The salary deferrals of highly paid employees meet certain IRS requirements. These requirements provide that contributions to the SEP are not made in a discriminatory manner favoring highly compensated employees.
Salary-deferral contributions cannot exceed certain limits, and amounts deferred in excess of these limits must be removed from the employee's SEP IRA. Excess contributions require special administrative handling and will be subject to penalties if not removed within a specific time frame.
The salary-deferral limits for SARSEP plans are as follows:
|Tax Year||Salary-Deferral Contribution Limit|
Eligible employees who are at least 50 years old by the end of the year may make additional contributions, which are referred to as catch-up contributions. Here are the catch-up contribution limits:
|Tax Year||Catch-up Contribution Limit|
Other rules could place additional limits on salary-deferral contribution amounts. Employees should consult with their employer and/or SEP IRA provider regarding limitations.
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