Simplified Employee Pension (SEP) Plans

Retirement Plans
Simplified Employee Pension (SEP) Plans

As a self-employed or small business owner, you can secure your retirement and that of your employees with a Simplified Employee Pension (SEP) Plan.

A simplified employee pension plan is an Individual Retirement Account (IRA) that provides a streamlined approach to retirement planning for self-employed and small business owners. The primary advantage of this pension plan is that it is easier to set up and has a lower operating cost than that of a traditional IRA.

SEP Plan Benefits

  • Only an owner contributes to a SEP plan, unlike a 401(k).
  • There is no filing requirement.
  • It is a low-cost option and is easy to create and operate.
  • An employer can make flexible contributions every year and even skip between yearly payments.
  • An employer can create the fund both for yourself and your employees simultaneously.
  • A contribution to the SEP plan is exempted from tax and will be taxable at the time of withdrawal.

SEP Plan Drawbacks

  • An employer must contribute equally to all the pension funds created for their employees, including the fund you have created for yourself.
  • You cannot contribute money to the SEP plan post taxes, unlike the Roth 401(k) plan.

Eligibility Requirements

An employee or a self-employed person who is eligible for a SEP plan:

  • Must be 21 years of age.
  • Must have worked at least 3 out of 5 years under the same employer.
  • Must have received payments of at least $650 from an employer during 2021 and 2022.

Employers can relax some eligibility criteria but cannot impose stricter requirements.

Employee exclusions from the SEP plan are:

  • Those who are getting retirement benefits by being union members.
  • Non-resident aliens who have not received any compensation from their employer.

You can open an SEP if you are self-employed or a small business owner and want to secure a retirement option for yourself and your employees.

You can set up an SEP plan by filling out Form 5305-SEP or a prototype of the same. You can choose a financial institution or a broker with whom you want to set up the account. Though not necessary, all employees’ SEP funds typically use the same financial institution.

SEP Plan Contribution Limits:

Employers can contribute to each employee's SEP plan up to 25 percent of their annual salary. They can also contribute $61,000 for 2022, subject to specific cost of living adjustments for later years, whichever is less.

When you are self-employed, you also contribute to your plan as you treat yourself as both employer and employee. To determine the amount you can contribute and deduct, you will need to do the following:

  1. Determine your net profit.
  2. Multiply your Self-Employed tax deduction by 0.50
  3. Subtract your reduced Self-Employed tax from your net profit.
  4. Multiply new net profit by your reduced plan contribution rate.
  5. The final total will be the amount you can contribute and deduct.

You can withdraw the contribution made to the SEP account at any time, subject to the restrictions imposed on traditional IRA. You need to pay taxes on the contributed amount at the withdrawal time. If you plan to withdraw before attaining 59.5 years, an additional 10 percent tax will be applied. You can rollover the contribution made under the SEP plan, tax-free, to any other retirement plan.

You can maintain a SEP plan for yourself or your employees by opening an account with any broker or financial institution. The contribution so made would be invested in a wide range of stocks and shares, ETFs, mutual funds and CDs to get the best returns on the investments in the long run.

To maintain a SEP plan, you need to contribute to the fund any time before the due date of filing your income tax return for the year.

After making the contributions, employees can make their own investment decisions. Your contribution to your employee's SEP accounts is automatically vested in them. To ensure your SEP operates as per the rules, you need to conduct an annual check-up.

Takeaway

Simplified employee pension plans are a simple way for self-employed people and owners of small businesses to have a tax-deferred benefit and a pension fund to secure their future after retirement.

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