Simplified Employee Pensions
Extensive paperwork, high costs and complicated administration associated with certain qualified retirement plans may cause many small businesses to shy away from establishing any retirement plan at all. This may be true of your small business, even though you recognize the many tax and employee retention benefits of providing a plan. Whether you are a doctor, lawyer, free-lance writer, artist, manufacturer’s representative or another type of self-employed business owner, the Simplified Employee Pension Plan, or SEP-IRA plan, may be a good fit for your small business.
Although a SEP IRA account is technically an Individual Retirement Arrangement (IRA), the SEP plan functions more like a cross between an IRA and a profit sharing plan. As with a profit-sharing plan, your small business may make a tax-deductible contribution to each employee’s SEP-IRA account up to the lesser of 25 percent of compensation or $44,000 (2006). The business owner has the flexibility to choose any level of contribution (within the above limits). The business owner has the discretion to set the contribution amount as low as zero. This can come in handy in years when business cash flow is a little less than desirable. But, it is the difference from, not the similarity to, a profit sharing plan that makes the SEP too good to overlook: the SEP is simple.
The simplicity of the SEP significantly distinguishes it from the traditional profit sharing plan. A SEP is easy to establish and maintain, which makes it less expensive than a profit sharing plan. The SEP may be established by any corporation (“S” or “C”), partnership, non-profit organization or sole proprietor. There is no complicated adoption agreement to purchase, complete or file with the Internal Revenue Service (“IRS”). A simple one-page form is all that is required to establish a basic SEP, and this form may be obtained at no cost.
Other aspects of the SEP illustrate its simplicity as well, including vesting and the allocation of contributions. SEP contributions are always 100% vested in the employees, so there is no vesting schedule to keep track of. Additionally, each employee receives the same percentage of pay contribution. So the contributions are easy to calculate. Alternatively, you may choose to purchase a SEP document that “integrates” with Social Security to provide a larger contribution for the higher wage earner, which is usually the business owner.
The uniformity of the SEP eligibility rules also creates simplicity. Eligibility rules are applied in the same manner to the business owner and each employee. SEP eligibility rules provide that the plan must cover employees who have reached age 21 and who have earned at least $450 in any three out of the last five years. Of course, you do not have to use the maximum three years of service. You may want to use a shorter period if, for example, your business is a younger than three so that you are not eliminated from your SEP.
The simplicity of the in-expensive SEP makes it a powerful tool for many small business owners. The above article mentions just a few of the many tax and retirement planning benefits that may make the SEP a good fit as one component in your business plan. For assistance in evaluating the fit of the SEP with your small business and before implementing any significant retirement planning strategy, please consult with your Financial Advisor.
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