SEP IRA Frequently Asked Questions


SEP IRA Questions - General

What is a SEP?
How do I establish a SEP?
What types of employers can establish a SEP?
If an employer has a SEP, can it also have other retirement plans?
If an employee participates in his or her employer's retirement plan, can he or she set up a SEP for self-employment income?
Is there a deadline to set up a SEP?
How is a SEP plan amended for EGTRRA?

SEP IRA Questions - Participation

Who is an eligible employee?
What is an example of the 3-of-5 rule?
Are there employees that may be excluded?
What happens if an employee elects not to participate?

SEP IRA Questions - Contributions

How much may be contributed to a SEP?
What is considered compensation? Are bonuses and overtime included?
How much may a self-employed individual contribute?
Must the same percentage of salary/wages be contributed for all participants?
Can catch-up contributions be made to a SEP?
Are there other limits on contributions?
Can a contribution be made to a SEP-IRA of a participant over age 70 1/2?
Must contributions be made to the SEP every year?
Do contributions have to be made for a participant who is no longer employed on the last day of the year?
What is the timeframe for depositing contributions into SEP-IRAs?
How much of the contributions made to employees' SEP-IRAs may be deducted on the business's tax return?
Are employer contributions taxable to employees?
What are the consequences to employees if excess contributions are made?
If a SEP fails to meet the SEP requirements, are the tax benefits for the employer and employees lost?

SEP IRA Questions - Termination of Plan

Does a SEP have to be amended for the new law before it terminates?
Does a SEP have to be funded in the year of termination?
What are the notification requirements to participants, etc., when a SEP terminates?
If the employer goes out of business or the employee terminates service, can the amount in a SEP-IRA be left untouched?


SEP IRA Questions - General

What is a SEP?

A SEP is a simplified employee pension plan. A SEP plan provides employers with a simplified method to make contributions toward their employees' retirement and, if self-employed, their own retirement. Contributions are made directly to an Individual Retirement Account or Annuity (IRA) set up for each employee (a SEP-IRA). See Publication 560 for detailed SEP information for employers and employees.
Note: The IRS has a system of correction programs for sponsors of retirement plans, including SEPs, which are intended to satisfy Internal Revenue Code requirements but have not met the requirements for a period of time. This system, the Employee Plans Compliance Resolution System (EPCRS), permits employers to correct plan failures and thereby continue to provide their employees with retirement benefits on a tax-favored basis.

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How do I establish a SEP?

A SEP is established by adopting a SEP agreement and having eligible employees establish SEP-IRAs. There are three basic steps in setting up a SEP, all of which must be satisfied.Back to top

What types of employers can establish a SEP?
Any employer can establish a SEP.

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If an employer has a SEP, can it also have other retirement plans?
An employer can maintain both a SEP and another plan. However, unless the other plan is also a SEP, the employer cannot use Form 5305-SEP; the employer must adopt either a prototype SEP or an individually designed SEP.

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If an employee participates in his or her employer's retirement plan, can he or she set up a SEP for self-employment income?
Yes. A SEP can be set up for a person's business even if he or she participates in another employer's retirement plan.

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Is there a deadline to set up a SEP?
A SEP can be set up for a year as late as the due date (including extensions) of the business's income tax return for that year.

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How is a SEP plan amended for EGTRRA?
If a prototype plan was used, the employer should have received an amended plan from the financial institution that provided it with the plan. If for some reason the employer didn't receive a new plan document, the financial institution should be contacted.

While the financial institution provides many administrative services for the plan, it is the responsibility of the employer - the plan sponsor - to ensure that the plan is kept up-to-date with current law.

If a model plan was used, an updated model plan should have been adopted by the end of 2002. See Form 5305-SEP.

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SEP IRA Questions - Participation

Who is an eligible employee?
An eligible employee is an individual who meets the following requirements: The employer may use less restrictive requirements to determine an eligible employee.

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What is an example of the 3-of-5 rule?
Assume an employer has a SEP with a requirement that an employee must work for it in at least 3 of the last 5 years (the maximum requirement) to receive an allocation under the plan. To be eligible for the 2006 year, for example, an employee must have worked for the employer for some time (no matter how little) in any 3 years in the 5-year period 2001 to 2005. Thus, an employee that worked for the employer in 2001, 2004 and 2005, must share in the SEP contribution made for 2006.

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Are there employees that may be excluded?
Yes, (a) employees covered by a union agreement whose retirement benefits were bargained for in good faith by the employees' union and the employer; and (b) nonresident alien employees who have no U.S. source compensation from the employer may be excluded.

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What happens if an employee elects not to participate?
The employer may establish a SEP-IRA on behalf of an employee who is entitled to a contribution under the SEP if the employee is unable or unwilling to establish a SEP-IRA.

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SEP IRA Questions - Contributions

How much may be contributed to a SEP?
Annual contributions an employer makes to an employee's SEP-IRA cannot exceed the lesser of:
1. 25% of compensation, or
2. $45,000 for 2007 ($46,000 for 2008 and subject to annual cost-of-living adjustments for later years).

The limits in the preceding sentence apply in the aggregate to contributions an employer makes for its employees to all defined contribution plans, which includes SEPs. Only up to $225,000 in 2007 ($230,000 in 2008 and subject to annual cost-of-living adjustments for later years) of an employee's compensation may be considered. Contributions must be made in cash. Property cannot be contributed.

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What is considered compensation? Are bonuses and overtime included?
Compensation considered is defined by the Internal Revenue Code and would include bonuses and overtime.

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How much may a self-employed individual contribute?
The same limits on contributions made to employees' SEP-IRAs also apply to contributions made to a self-employed individual's SEP-IRA. However, special rules apply when figuring out the maximum deductible contribution. See Publication 560 for details on determining the contribution amount.

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Must the same percentage of salary/wages be contributed for all participants?
Most SEPs, including the IRS model Form 5305-SEP, require that allocations to all employees' SEP-IRAs be proportional to their salary/wages. A self-employed owner's contribution is based on net profit minus one-half self-employment tax minus the contribution for him or herself. See IRS Publication 560 on determining the contribution amount.

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Can catch-up contributions be made to a SEP?
No. SEPs are funded by employer contributions only. However, catch-up contributions can be made to the IRAs that hold the SEP contributions if the SEP-IRA documents allow. The catch-up IRA contribution amount (for employees age 50 and older) is $1,000 for 2006 and later years

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Are there other limits on contributions?
Yes, if an employer contributes to another defined contribution plan for its employees, for example, a 401(k) plan, an annual addition limit applies. The annual addition limit for 2007 is the lesser of $45,000 ($46,000 for 2008 and subject to annual cost-of-living adjustments for later years) or 100% of the employee's compensation. In determining this limit, contributions for employees to all defined contribution plans of the employer, which includes SEPs, must be included.

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Can a contribution be made to a SEP-IRA of a participant over age 70 1/2?
Contributions must be made for each eligible employee in a SEP, even if over age 70 1/2. Such an employee must take minimum distributions, however.

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Must contributions be made to the SEP every year?
No, contributions are not required to be made every year, but in years contributions are made to the SEP, they must be made to the SEP-IRAs of all eligible employees.

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Do contributions have to be made for a participant who is no longer employed on the last day of the year?
A SEP cannot have a last-day-of-the-year employment requirement. If the employee is otherwise eligible, they must share in any SEP contribution. This includes eligible employees who die or quit working before the contribution is made.

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What is the timeframe for depositing contributions into SEP-IRAs?
Contributions for a year must be deposited by the due date (including extensions) for filing your Federal income tax return for the year.

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How much of the contribution made to employees' SEP-IRAs may be deducted on the business's tax return?
The most that may be deducted on the business's tax return for contributions to its employees' SEP-IRAs is the lesser of its contributions or 25% of compensation. (Compensation considered for each employee is limited to $225,000 in 2007, $230,000 for 2008 and subject to annual cost-of-living adjustments for later years.) If the employee is self-employed and contributes to his or her own SEP-IRA, a special computation to figure out the maximum deduction for these contributions must be made. When figuring the deduction for contributions made to a self-employed individual's SEP-IRA, compensation is net earnings from self-employment which takes into account the following deductions:
1. the deduction for one-half of the individual's self-employment tax, and
2. the deduction for contributions to the individual's own SEP-IRA.
See Publication 560 for details on determining the deduction.

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Are employer contributions taxable to employees?
No, contributions to employees' SEP-IRAs are not included in their gross income, unless they are excess contributions.

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What are the consequences to employees if excess contributions are made?
If contributions are made in an amount that is more than is allowed, there are tax implications for the employer and the employees. Excess contributions are included in employees' gross income. If an employee withdraws the excess contribution, and earnings on such amount, before the due date for filing his/her return, including extensions, the employee will avoid a 6% excise tax imposed on excess SEP contributions in an IRA. Excess contributions left in the employee's SEP-IRA after that time may result in adverse tax consequences to the employer and the employee. If the employer contributes more than it may deduct, it may be subject to a 10% excise tax.

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If a SEP fails to meet the SEP requirements, are the tax benefits for the employer and employees lost?
Generally, tax benefits are lost if the SEP fails to satisfy the Internal Revenue Code requirements. However, the employer can retain the tax benefits if it uses one of the IRS correction programs to correct a failure. In general, when correcting a failure under the program, the correction should put employees in the position they would have been had the failure not occurred.

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SEP IRA Questions - Termination of Plan

Does a SEP have to be amended for the new law before it terminates?
Generally, the IRS has not required SEPs to be amended for new law prior to termination. Check with your plan professional.

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Does a SEP have to be funded in the year of termination?
SEPs can be terminated at any time. The employer can stop funding these plans once they are terminated.

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What are the notification requirements to participants, etc., when a SEP terminates?
When terminating a SEP plan, it is a good idea to notify the employees that the plan has been discontinued. The financial institution that was chosen to handle the plan may need to be notified that there will be no more contributions. The employer may also need to let the institution know that it will terminate the contract or agreement with it. The IRS should not be notified of the plan's termination.

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If the employer goes out of business or the employee terminates service, can the amount in a SEP-IRA be left untouched?
Yes.

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