Employee Benefits Spotlight: SEP (Simplified Employee Pension)

Monday, July 18, 2022 13:04 Posted by Admin

Many small businesses want to help their employees prepare for retirement but aren’t sure they have the size to warrant a retirement plan like a 401(k). For some, the answer may be a Simplified Employee Pension plan, with which a company can contribute toward their workers’ retirements and augment their own as well. For example, the employer can contribute to an IRA for each participating employee with a SEP.

According to the IRS, any employer, including self-employed persons, can establish a SEP. The three steps for getting started are:

• Create a formal document that includes the written agreement for participants to sign. The IRS has a prototype, and financial institutions also have samples you can use when setting up the account in their custody.
• Provide every employee with information about the SEP.
• Establish a SEP-IRA (individual retirement account) for each employee in a qualified financial institution. The IRA belongs to and is controlled by the employee.

If a business creates a SEP, the employer can determine the eligibility requirements but must allow the following:

• Any employee at least age 21
• Has worked for the company in at least 3 of the most recent five years
• Was paid at least $650 in 2021 or 2022 (as part of the three years) and $600 if the qualifying years are 2016-2020.

The employer can set a lower age minimum or allow workers to receive immediate or quicker eligibility if preferred. However, the requirements must be the same for all employees.

How is a SEP funded?

The employer makes contributions to the SEP account, subject to IRS limits. The contributions must be the same percentage of compensation for each employee and cannot be greater than 25 percent of salary, with a dollar limit in 2022 of $61,000. The SEP-IRA can also receive contributions from an employee up to the maximum annual contribution limit in many cases. If the SEP-IRA does not permit employee contributions, the employee can still make contributions to another IRA. However, the taxpayer needs to be aware that contributions to the SEP-IRA may reduce the amount they can contribute to other traditional and Roth accounts.

Typically, the employee can choose from investment options and manage their own account selections. Earnings, like contributions, are tax-deferred. However, withdrawals taken in retirement are taxed at the person’s tax rate at that time.

What rules does the employer need to follow?

It’s a good idea to talk to your Taylor Benefits Insurance employee benefit plans specialist about your SEP, but here are some points to keep in mind:

• You can skip a year. The employer does not have to contribute every year once they establish the SEP program. However, if they make contributions, all eligible employees must receive one.
• Don’t overlook employees who leave. If a worker meets the eligibility requirements but leaves before year-end, they still need to receive the same contribution based on salary.
• Don’t overlook workers of retirement age. Even if an employee must take minimum withdrawals from their retirement accounts due to age, the employer must still contribute.
• Contributions are tax-deductible to the employer and exempt from employees’ gross income unless the amount exceeds the allowable limits (25 percent of compensation or $61,000.)

SEP IRAs are attractive to sole proprietors and small companies due to their ease of implementation, low maintenance administration, and flexibility.