Certain individual retirement accounts or individual retirement annuities may qualify as a simplified employee pension (SEP). Under a SEP each employee’s contributed funds are placed in an individual retirement account (IRA) that the employee controls as an investment and the distributions. Our tax attorneys in Denver have helped many individuals understand the tax implications of a SEP and other retirement vehicles. The article below should act as a general guide to understanding a SEP. If you have questions, please contact a Denver tax attorney at The McGuire Law Firm.
Under IRC Section 408(k), SEP individual retirement accounts have five characteristics: Contributions may not discriminate in favor of highly compensated employees; the SEP must be an individual retirement account or individual retirement annuity; the employer must make contributions to the SEPs of all employees; employees must be allowed to withdrawal portions without penalty imposed by the employer; and, the employer contributions must be allocated to the SEPs of the employees per a written formula specifying how the contribution is to be divided and how much each of the contribution an employee may expect to receive.
If the SEP is established using an IRS form or certain information is provided to eligible employees, the employer may qualify for relief from reporting and disclosure requirements otherwise required by ERISA. Generally, this relief would come in the form of not being required to file Form 5500 as well preparing and distributing a plan description and summary to employees.
A SEP may only be established by an employee. Thus, an individual must first be an employee and under a SEP arrangement or plan before an IRA can be used as a SEP. A sole proprietor may establish a SEP because they are treated as their own employer. Further, a partnership can establish a SEP as the partners are considered employees of the partnership under IRC Section 408.
A SEP requires a written document executed by the employer, which must be in place by the latest date allowed by law for employer deductible contribution. This is an advantage to other qualified plans under IRC Section 401. For example, Joe could create a SEP arrangement and contribute to the SEP on or before April 15, 2009 for the 2008 tax year. However, an IRC Section 401 qualified plan would need to be executed by December 31, 2008.
The written SEP arrangement must include four elements: the name of the employer, the requirements for an employee to receive an allocation or share of the employer’s contribution; the equation for allocating the employer’s portion amongst those employees that are eligible; and, a responsible officer must sign the written document. The written instrument requirement can be satisfied by the employer filing Form 5305-SEP.
An employer considering the creation of a SEP should obtain information from their tax attorney, business attorney and/or financial advisor regarding the requirements and tax implications to their business. A Denver tax attorney or business attorney at The McGuire Law Firm would be happy to assist you with any questions you may have.