These frequently asked questions and answers are provided for general information only and should not be cited as any type of legal authority. They are designed to provide the user with information responsive to general inquiries. Due to the uniqueness and complexities of Federal tax law, it is imperative to ensure a full understanding of the specific question presented, and to perform the requisite research to ensure a correct response is provided.
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IRAs are the investment vehicles for IRA-based plans (e.g., SEP, SIMPLE IRA and SARSEP plans). All SEP-IRAs and SIMPLE IRAs are subject to the same investment rules as traditional IRAs. For more information on distributions, loans and investments in IRAs, please see the IRA FAQs.
General
Participation
Contributions
Termination of Plan
Have a Question?
General
- What is a SEP?
- How is a SEP established?
- 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?
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.
How is a SEP established?
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.
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A formal written agreement must be executed. This written agreement may be satisfied by adopting an Internal Revenue Service (IRS) model SEP using Form 5305-SEP, Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement. A prototype SEP that was approved by the IRS may also be used. Approved prototype SEPs are offered by banks, insurance companies, and other qualified financial institutions. Finally, an individually designed SEP may be adopted.
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Each eligible employee must be given certain information about the SEP. If the SEP was established using the Form 5305-SEP, the information must include a copy of the Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions. If a prototype SEP or individually designed SEP was used, similar information must be provided.
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A SEP-IRA must be set up for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. The SEP-IRA is owned and controlled by the employee and the employer sends the SEP contributions to the financial institution where the SEP-IRA is maintained.
What types of employers can establish a SEP?
Any employer can establish a SEP.
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.
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.
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.
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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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?
Who is an eligible employee?
An eligible employee is an individual who meets the following requirements:
- attained age 21;
- has worked for the employer in at least 3 of the last 5 years;
- has received at least $500 (subject to annual cost-of-living adjustments) in compensation from the employer for the year.
The employer may use less restrictive requirements to determine an eligible employee.
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.
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.
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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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?
How much may be contributed to a SEP?
Annual contributions an employer makes to an employee’s SEP-IRA cannot exceed the lesser of:
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25% of compensation, or
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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.
What is considered compensation? Are bonuses and overtime included?
Compensation considered is defined by the Internal Revenue Code and would include bonuses and overtime.
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.
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.
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.
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.
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.
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.
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.
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.
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:
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the deduction for one-half of the individual’s self-employment tax, and
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the deduction for contributions to the individual’s own SEP-IRA.
See Publication 560 for details on determining the deduction.
Are employer contributions taxable to employees?
No, contributions to employees’ SEP-IRAs are not included in their gross income, unless they are excess contributions.
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.
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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Termination of Plan
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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.
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.
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.
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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Have A Question?
If I have questions concerning SEPs, where do I go for help?
You may direct your technical and procedural questions concerning retirement plans to TE/GE Customer Account Services at (877) 829-5500 (a toll-free number). The call center is open 8:30 a.m. to 4:30 p.m. Eastern Time.
Or you may e-mail us at:
RetirementPlanQuestions@irs.gov
Note: All questions submitted via e-mail must be responded to via telephone, so please remember to include your telephone number in your message.
Or you may write us at:
Internal Revenue Service
TE/GE Division, Customer Service
P.O. Box 2508
Cincinnati, OH 45201
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