Simplified Employee Pension
A simplified employee pension, or SEP, is the simplest, most efficient, and
least expensive way for a small business to establish a pension (defined benefit
plan) plan for its owners and employees.
What is a SEP? SEPs are essentially individual
retirement accounts (or IRAs) in that they still act in many respects like
pension plans but are much easier and less expensive to administer.
While the "S" in "SEP" stands for "simplified,"
if you have employees, the process of creating and administering a SEP is not
all that simple. If you're interested in establishing a retirement plan, you
must consult your financial and legal advisors about how to create and
administer the plan. This discussion is designed to acquaint you with some of
the major steps in creating and administering a SEP.
A sample SEP
is available in the Business Tools area.
Who should set up a SEP? If you fall into one of these categories, you
should consider setting up a SEP:
- persons who are regularly employed by a company but who
"moonlight" for themselves as independent contractors (In fact,
that's why some commentators have referred to SEPs as a "moonlighter's
- sole proprietors who have no employees — for these folks, establishing a
SEP is as simple as walking into a bank or brokerage firm and setting up an
IRA account (Just tell them that you want a SEP-IRA.)
- any business that won't know its financial condition until tax time
(because SEPs are the only type of employer-sponsored retirement plans that
can be established after the employer's tax year has ended, and where
contribution amounts can be determined after you see what your profits will
be for the year)
- persons or companies providing financial services who might want to use a
SEP to provide clients with combined plan and investment services (one-stop
shopping for retirement plan and investment services is attractive to busy
Who shouldn't set up a SEP? You should stay away from SEPs if you:
- want to set up a retirement plan that gives you a lot of flexibility; in
allowing employers to set up SEPs, Congress traded off flexibility for lower
costs and fewer administrative burdens
- foresee wanting to contribute in a given year more than the limit Congress
has placed on annual SEP contributions (the lesser of 15 percent of
compensation or $40,000 for 2002; $35,000 for 2001)
- have high income and you don't want to be limited by the rule that allows
you to use only the first $160,000 in income to compute the contribution
Setting up a SEP. To set up a SEP, you need to take three steps, which
are, in order:
- Determine your contributions
IRAs for all your eligible employees.
all blanks on IRS Form 5305-SEP (or create your own document with
similar information in it), and sign and date it.
If you decide to create a SEP, make joining it a condition of
employment for all employees. Otherwise, an employee who chooses
not to participate could create adverse tax consequences for
those who do participate.
Administration. There are also many administrative issues involved in
offering a SEP, including: