Self Employed

Simplified Employee Pensions (SEPs)

Self-employed individuals have different rules and products for retirement saving.

If you’re self-employed and looking for true simplicity, look no further. A SEP is an employer retirement plan that uses IRAs as the funding vehicle. In 2007, you can contribute up to $45,000 or 25% of compensation, whichever is less. The actual formula limits your contribution to 20% of your net self-employment income. You can even make your regular IRA contribution to your SEP, in addition to your regular SEP contribution.

HOT TIP: Your contribution can vary from year to year; you can even skip contributions indefinitely. While this is probably not in your best interest, you also don’t have to be bothered with complicated plan documents or annual filing requirements.

CAUTION: As in a regular IRA, you can’t borrow from a SEP, nor can you use the assets as collateral for a loan. In addition, the rules against putting collectibles in your IRA also apply to SEPs.

Are You Eligible?

Only an employer can establish a SEP arrangement. In order to sponsor a SEP, you can either be in business by yourself or have employees. If you have eligible employees, you must fund the SEP on their behalf; that is, you must make contributions to the SEP plan for your eligible employees. You, as the employer, are also responsible for establishing and maintaining the plan.

The participation requirements for a SEP are generally broader than those for Keogh plans. An eligible employee for a SEP is one who: (1) is at least 21 years old; (2) has performed service for you in at least 3 of the immediately preceding 5 years; and (3) receives a minimum amount of compensation set annually by the IRS.

CAUTION: Because of the less restrictive participation rules (see above), SEPs are typically less popular for employers than other retirement plans.

Supercharging Your IRA

A SEP is better than an IRA because an IRA allows you to put away only up to $4,000 in 2007. SEPs are IRAs that an employer sets up for its employees as part of a retirement plan. Like a qualified plan, SEPs are subject to overall contribution limitations (similar to a Keogh plan).

Salary Reduction SEP

A salary reduction SEP (SARSEP) is a SEP established before 1997 that includes a salary reduction arrangement. This plan allows the employee to elect to have the employer contribute part of his or her pay to the SEP or to pay the employee directly in cash. This cash or deferred arrangement is similar to a 401(k) plan and allows the employee to make excludable IRA contributions which exceed the normal IRA limits.

Contributions made to a SEP-IRA, including elective deferrals, are subject to the overall SEP limitations discussed above.

SARSEPs can no longer be established; however, current programs may continue. If you are interested in setting up a retirement plan that includes a salary reduction arrangement, see the section SIMPLE Plans.

Setting Up A SEP

Administrative simplicity is one of the primary advantages of simplified employee pensions (SEPs). SEPs are easy to open and require less paperwork than qualified plans. Unlike Keoghs, SEPs require no plan document other than a standardized IRS form(Form 5305-SEP). If you don’t adopt an IRS approved prototype plan, you must prepare and adopt a written plan that satisfies the IRS requirements.

Unlike Keoghs, you have until the due date of your income tax return (including extensions) to both establish and contribute to the SEP. Typically, the employees (including you) can choose how their SEP funds are invested. Usually the investments are certificates of deposit, annuities, or mutual funds.

Where to Set Up A SEP

Your local bank, savings institution, insurance company, or mutual fund or brokerage firm can open a SEP for you. All that is required is a simple one-page document (Form 5305-SEP) to be completed by you, the employer. Setup and annual fees, per plan, may apply.

Reporting Requirements

The reporting and disclosure requirements for SEPs are less cumbersome and costly to employers than other retirement plans. All that is required is Form 5305-SEP (Simplified Employee Pension-Individual Retirement Accounts Contribution Agreement), a one page, easy to complete, form. This serves as the written plan instrument. The form is not filed with the IRS, but it should be kept in the employer’s records to support the legal adoption of the arrangement.

CAUTION: Each employee must be given a copy of the completed Form 5305-SEP. Also, each year, a statement must be given to each employee showing any contributions to the employee’s SEP.