SEP IRAs: Contributions
SEP contributions are made on a discretionary basis, which means the employer decides each year whether to make contributions to the plan.
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 an eligible employee's compensation for a year, provided the contribution does not exceed $55,000 (indexed) for 2018. Employee compensation in excess of the compensation cap of $275,000 (indexed) for 2018, is not considered when calculating SEP contributions. The compensation cap is the maximum compensation that may be considered for employer-plan purposes.
An employer is eligible to receive a tax deduction for contributions made to the plan, within established IRS regulatory limits.
An employer may choose from several IRS-approved formulas to allocate contributions to employees' SEP IRAs:
With this formula, each eligible employee receives the same percentage of his or her eligible compensation. For example, if the employer decides to make a contribution of 10% of compensation for the year, then every eligible employee would receive 10% of his/her compensation as a SEP IRA payment, up to the maximum of $55,000.
- Flat-Dollar Formula
With this formula, each eligible employee receives the same dollar amount as a contribution, again up to the $55,000 maximum.
- Social Security Integration
Here, higher-paid employees receive a larger percentage of the contribution. With this formula, the employer contributes 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 could be disqualified. Don't do this one without serious accounting help.
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. 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, new SARSEPs could no longer be established. Employers that established SARSEPs prior to January 1, 1997, are allowed to continue maintaining these plans. Here's how they work:
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 choose 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-Contribution Limits
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 limit for a SARSEP is $18,500 for 2018. Eligible employees who are at least 50 years old by the end of the year may make an additional contribution of $6,000.
Other rules could place additional limits on salary-deferral contribution amounts. Employees should consult with their employer and/or SEP IRA provider regarding limitations.