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Simplified employee pension (SEP).

A simplified employee pension (SEP) is an employee's individual retirement account that may accept an expanded rate of contribution from his employer. Because payments are made into an IRA established for each employee, they are also referred to as SEP IRAs. SEPs can be established with sole proprietorships, partnerships, or corporations, and are particularly attractive for the self-employed who has no employees or the individual who has additional income from outside employment. Generally, all employees must be included in a SEP except for: (1) employees who have not worked for the employer three out of the last five years; (2) employees who earn less than $550 (as indexed for inflation); (3) employees who have not reached age 21; (4) employees covered by a collective bargaining agreement; and (5) non-resident aliens. They are generally easy to set up and require little administration.

SEPs can be established and funded as late as the due date (plus extensions) of the employer's (or self-employed's) tax return. In 2009 and 2010 pre-tax contributions are limited to the lesser of $49,000 or 25 percent of the first $245,000 of net earned income (with sole proprietorships and partnerships the owners are effectively limited to 20 percent). No minimum funding standards are imposed. Contributions are not subject to income tax withholding, FICA or FUTA. Typically these plans are self-directed, in that the individual participant decides how funds will be invested. All earnings within the plan accumulate on a tax-deferred basis. The employer may not prohibit withdrawals from the plan, although they may be subject to a penalty tax if made before age 59V. Essentially, there are four types of SEP plans with varying degrees of complexity:

5305-SEP is very easy to implement, requiring only the completion of five questions on IRS Form 5305-SEP. However, this may not be used by employers who maintain other qualified retirement plans, use leased employees, or have had a defined benefit plan.

SEP prototype plans are provided by financial institutions (with or without a fee). Prototype plans are particularly useful if the employer wants to integrate the SEP contributions with Social Security (i.e., provide increased contributions for highly paid employees).

Individually designed plans are typically drafted by an attorney. They tend to be more expensive and complicated, therefore less often used.

SAR-SEP plans are salary reduction SEPs that allow employees to make pretax contributions to their IRAs. The provisions permitting the establishment of these plans were terminated at the end of 1996. SAR-SEPs already in existence prior to 1997 may continue to operate under preexisting law, receive contributions, and add new employees, but new SAR-SEPs may not be established. In their place, individuals may wish to consider the SIMPLE IRA (see discussion on page 541).

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Title Annotation:Terms & Concepts
Publication:Field Guide to Estate, Employee, & Business Planning
Date:Jan 1, 2010
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