SEPs

Simplified

Employee

Pensions

What

Small

Businesses

Need

To

Know

U.S. Department of Labor

Pension and Welfare Benefits

Administration
This publication has been developed by the U.S.

Department of Labor, Pension and Welfare

Benefits Administration. It is available on the

Internet at:

http://www.dol.gov/dol/pwba

For a complete list of PWBA publications, call the

toll-free Publication Hotline at:

1-800-998-7542.

This material will be made available in alternate

format upon request:

Voice phone: (202) 693-8664

TTY: (202) 501-3911

This booklet constitutes a small entity compliance

guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996.
Simplified

Employee

Pensions

SEPs

Revised -- October 2001
Introduction

Simplified Employee Pensions - known as SEPs -

represent an easy, low-cost retirement plan option

for employers. Instead of establishing a separate

retirement plan, in a SEP the employer makes

contributions to his or her own traditional Individual Retirement Account (IRA) and the IRAs of

his or her employees, subject to certain percentages

of pay and dollar limits. Employers who establish

SEPs can:

Make tax deductible contributions to their

own and their employees' IRAs.

Omit or reduce contributions in years

when contributions are unaffordable.

Avoid the administrative costs and the

reporting requirements of conventional

plans.

Whether a SEP is appropriate for your business

will depend on factors such as revenue, firm size

and the age, compensation and retirement needs of

the business owner and work force. You may want

to discuss other retirement plan options with a

professional advisor.

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WHAT ARE

SEPs are retirement programs established by you,

as an employer, which allow you to provide

retirement benefits for yourself and your employees

without paying the start-up and operating costs of

conventional plans.

SEPs allow an employer to establish and make

contributions to traditional IRAs (Roth IRAs cannot be used with SEPs). The two critical differences between SEP-IRAs and other IRAs are:

SEP contributions are generally made by

employers, not employees.

The amounts contributed to IRAs under

SEPs can be much larger than the amounts

contributed without a SEP.

As a general rule, up to 15 percent (25 percent

after 2001) of each employee’s pay - including your

own - can be put into a SEP-IRA each year.

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SEP-IRAs

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WHY SET UP A

Advantages for you

as an employer

A SEP can provide a significant source of

income at retirement.

Contributions to a SEP are tax deductible and

your business pays no taxes on the earnings on

a SEP’s investments.

You are not locked into making contributions

in future years. You can decide each year

whether to pay into the SEP and how much to

contribute.

Once you put money into a SEP you have no

further responsibility for the amounts contributed. The funds are managed by a financial

institution.

A SEP can be established and operated

without the administrative expenses, consulting fees or commissions usually associated

with maintaining a conventional retirement

plan.

Beginning in 2002, small employers with no

more than 100 employees may be eligible

for a tax credit for costs incurred of up to

50 percent of start-up costs.

You ordinarily do not have to file any documents with the government.

SEPs can be set up by sole proprietors,

partnerships and corporations, including S

corporations.

You can deduct contributions to a SEP for a

previous tax year if you make contributions by

the due date of the employer’s tax return,

including any extensions.

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The money you contribute to your employees’ SEP accounts, as well as the investment

earnings, belongs to them - even if they stop

working for you.

Employers’ contributions to the SEP-IRA are

not included in employees’ income for income

tax purposes.

Employees pay no taxes on the amounts in

their SEP accounts until they start

withdrawing the funds.

Employees can change the financial institution

where their SEP is invested.

In case of an employee’s death, the assets in

a SEP will go to someone the employee has

chosen.

SEP contributions can continue until

employees retire, but they must start

withdrawing assets from a SEP when they

reach age 701⁄2.

Some employees may be eligible for a

nonrefundable tax credit of up to $1,000 for

making elective deferrals to a SEP beginning

in 2002.

Employees age 50 and older can make

increased or "catch up" contributions

beginning in 2002.

Advantages for

your employees

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SEP

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ESTABLISHING A

You can set up a SEP by using the Internal Revenue Service’s “model SEP” agreement Form 5305-

SEP. All you have to do is:

Decide the percentage of pay you want to

contribute to the SEP. The contribution is

limited to 15 percent of pay or $25,500 (for

2001), (25 percent of pay or $40,000 for

2002), whichever is smaller. A uniform

percentage of pay must be contributed for each

employee.

Fill out Internal Revenue Service Form 5305-

SEP, a short form with instructions. This form

is not filed with the Internal Revenue Service.

Set up an IRA at a financial institution to

receive your SEP contributions. An IRA can

be set up by or for your employees to receive

the contributions you make for them.

Mail the SEP contributions to the financial

institutions.

Give employees eligible to be included in the

SEP a completed copy of the Form 5305-SEP

and the other documents and disclosures listed

in the instructions, including an annual

statement to each participating employee of the

amounts contributed to their account for the

year.

No other reporting or disclosure ordinarily

is required.

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(1)

(2)

(3)

(4)

(5)
You cannot use the IRS “model SEP” if you

currently maintain any type of qualified retirement

plan or use the services of leased employees. You

also cannot use the model SEP if you have any

eligible employees for whom accounts have not

been established. For this purpose, eligible employees include certain individuals who have a specific

relationship to the employer. For example, eligible

employees for purposes of SEP con-tributions

include employees or an “affiliated” or “commonly

controlled” group of employers of which you are a

member. These are technical terms that are

defined in the Internal Revenue Code. If you

believe any of these terms apply to you, you should

consult a professional advisor.

Although using the IRS Form 5305-SEP is an easy

way to set up a SEP, you do not have to use this

model agreement. Many financial institutions have

their own SEP arrangements that have been

approved by the Internal Revenue Service.

If you use a non-model SEP, the law allows you to

take into account Social Security contributions you

made for your employees. If you want to do this,

consult your professional advisor.

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SEP
WHO

MUST BE

INCLUDED IN A

SEP

Generally, any employee who performs services for

certain affiliated or commonly controlled employers

(see the discussion on page 5 regarding these

terms) must be included in a SEP. However, there

are five exceptions to this general rule. Employers

may exclude from the SEP:

Employees who have not worked for the

company during 3 out of the last 5 years.

Employees who earn less than $450* (for

2001) a year.

Employees who have not reached age 21

during the calendar year for which

contributions are made.

Employees covered by a collective bargaining agreement, if retirement benefits were

the subject of good-faith bargaining.

Nonresident aliens who do not earn U.S.

source income from you.

* This number is indexed for inflation each year.

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SALARY REDUCTION

SEPs

Starting January 1, 1997, employers may no longer

set up Salary Reduction SEPs. However, the Small

Business Job Protection Act of 1996 (Public Law

104-188) permitted employers to establish

SIMPLE IRA plans beginning in 1997. A

SIMPLE IRA plan allows salary reduction contributions of up to $6,000* annually ($7,000 in

2002).

* This number is indexed for inflation each year.

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SEP

INVESTMENTS

Financial institutions authorized to hold and invest

SEP contributions include banks, savings and loan

associations, insurance companies, certain regulated investment companies, federally insured credit

unions and brokerage firms. SEP con-tributions

can be put into stocks, mutual funds, money

market funds, and other similar types of investments.

You and your employees will receive a statement

from the financial institutions investing your SEP

contributions both at the time you make the first

SEP contributions and at least once a year after

that. Each institution must provide a plainlanguage explanation of any fees and commissions

it imposes on SEP assets withdrawn before the

expiration of a specified period of time.

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If an employer maintains a SEP for its employees, can the employees also make contributions to Individual Retirement Accounts?

Yes. If the employees choose to do so, they may

combine IRA and SEP contributions in one

account. NOTE: Because SEP contributions make

an individual an "active participant in a qualified

plan" for IRA purposes, IRA contributions of

certain employees may not be tax deductible. See

IRS Publication 590.

Can an employee eligible to participate in a

SEP choose not to participate?

No. All eligible employees must participate. An

employer can set up an IRA for the employee at

a financial institution and make the appropriate contribution.

Does the employer have to pay Social

Security or Federal unemployment compensation taxes on SEP contributions for employees?

No.

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COMMONLY ASKED

QUESTIONS ABOUT

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Do employers in companies with Salary

Reduction SEPs have to pay Social Security

taxes on their employees’ pre-tax contributions?

Yes. In addition, employees have to pay their

portion of Social Security taxes.

When are income taxes paid on money in a

SEP account?

Income taxes are paid when money is withdrawn from a SEP account.

When can money be withdrawn from a SEP

account?

SEP money can be withdrawn without penalty

at age 591⁄2. Earlier withdrawals are generally

subject to a 10 percent additional income tax

unless the participant becomes disabled or

receives distributions in the form of an annuity

that are part of substantially equal payments

over life or life expectancy.

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SEP
FOR MORE

INFORMATION ABOUT

SEPs

Call the nearest office of the Internal Revenue

Service, go to their Web site at www.irs.gov or call

1-800-TAX-FORM for Publication 590 and Form

5305-SEP if you are interested in the IRS model

SEP. This form and its instructions will help you

understand how SEPs work.

For additional copies of this booklet, call the

Pension and Welfare Benefits Administration's toll

free publications line at 1-800-998-7542 or go to

the Web site at www.dol.gov/dol/pwba.

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