Pension plans specifically intended for self-employed individuals and small businesses are called Simplified Employee Pension (SEP) Plans. It’s also known as SEP/IRAs because they utilize individual retirement accounts. It was created by the Congress and managed by the IRS, giving small business owners and employees the opportunity to save their money for retirement as traditional large corporate pension funds. All types of business entities such as proprietorships, partnerships, and corporations can take advantage of SEP plans.
What are the benefits of SEP?
Small businesses in SEPs are able to direct at least 3 percent and up to 15 percent of each employee’s annual salary into tax-deferred IRAs with a right to be discreet about it. SEP plans can be set up easily and can be administered at an affordable cost since the employer only have to make contributions to IRAs created by employees. Investment decisions involving their own SEP account can then be taken by the employees. As a result, employers are able to avoid the risk and cost related to the accounting for employee retirement funds. Employers also have the freedom to make large percentage contributions if the company is doing well financially during the year as well as lessen the contributions during difficult times. In addition, a tax break is given to employers and awesome benefit for employees just like other tax-deferred retirement plans provides.
SEPs are more flexible and attractive compared to corporate pensions as they can be an alternative for corporate pensions and 401(k) plans. Individuals who work full use SEP to save and invest more money for retirement compared to what they might normally be saved as per the IRS rules.
What are the rules governing SEPs?
Although the rules that governs SEPs are simple, they do change frequently which is why a review of IRS publications 560 and 590 annually is best to be done. Setting up SEPs starting year 2000 has been made simpler by Form 5305-SEP that no longer requires a separate trustee unlike other huge and more complex pension plans. The maximum allowance contribution per employee as of 2006 was 25 percent of the first $220, 000 of an employee’s eligible compensation or $44, 000 whichever is less among them. Generally, employees who are 21 or older are the only ones who eligible with a service of at least one year to the company and compensation of a minimum level. The maximum level of compensation is $170, 000 for SEP eligibility.
Comparing the Benefits of Owners and the Non-owner Employees
Here is what you need to know about SEPs. A small business owner wanting to create a SEP or any other qualified retirement plan for him or herself is required to include all other company employees who were able to meet the minimum participation standards. As an employer, retirement plans can be established by the employer like any other business. On the other hand, as an employee, the small business owner can then make contributions to the plan that he or she established allowing him or her to save tax-deferred funds for retirement just like any other employee. The difference is that in any company-sponsored retirement plans, a small business owner must include all nonowner employees as well as in making fair contributions to their accounts. The negative effect of this requirement, however, reduces the allowable contributions the owner of a proprietorship or partnership can make on his or her own behalf.
Self-employed individuals can make contributions based on the net earnings of their business. Included in the net earnings are company’s gross income fewer deductions for business expenses, salaries that are paid to non-owner employees, 50 percent of the Social Security Tax of the employer, and last but not the least, the employer’s contribution to retirement plans representing the employees. This means instead of receiving pre-tax contributions to the retirement account as a percentage of gross salary, the small business owner receives contributions as a small percentage of net earnings like nonowner employees. The owner won't be able to build up a huge before-tax retirement account of his or her own if more people have to be employed.
However, SEPs remains to be one of the best plans for self-employed individuals and small business owners. Compared to the high annual pre-tax contribution of a standard IRS, it offers less and people can still contribute to their existing IRAs and 401(k)s while also participating in a SEP plan.
