A simplified employee pension (SEP) plan is ideal for the self-employed or for small corporations as it requires minimum paperwork and offers a maximum of flexibility. It is the only employer plan requiring no IRS approval, no initial filings and no annual reporting to the government.
Although SEPs are designed as pensions, they are actually IRAs. Unlike regular IRAs, however, contributions are not limited to $2,000. The total deferral can be up to $30,000 or 15 percent of annual earnings (about 13 percent for self-employment income), whichever is less.
Contributions must be made on a nondiscriminatory basis to all employees who are at least age 21 and who have worked for any part of three of the past five years earning a minimal amount -- $374 in 1992 and adjusted annually for inflation. Contributions can vary from year to year -- you may even skip entire years -- and must be paid no later than the due date of an employer's income tax return, including extensions. Once made, the entire contribution is owned by the employee.
Complete specifications for the plan can be found in IRS Form 5305. The form itself serves as the plan document, requiring only the insertion of business name, the checking of three boxes and a signature. The form is not filed with the IRS, but rather copied for all employees and then placed in the firm's files.
Under a new type of SEP, called a Salary Reduction SEP (SAR-SEP), employees can defer, or set aside, a portion of pay as a pre-tax contribution. Deferred contributions, like other SEP contributions, are excludable from the employee's gross income for calculating federal income tax. However, SAR-SEPs are allowed only if fewer than 25 employees were employed during the preceding year. In addition, periodic testing is required.
