Simplified Employee Pension Plan – Not Always So Simple

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The Simplified Employee Pension Plan or SEP is a retirement plan designed to benefit self-employed individuals and small business owners. Sole proprietorships, S and C corporations, partnerships and LLCs can establish a SEP.
The SEP plan provides employers with a simplified method to make contributions toward their employees’ retirement and, if self-employed, their own retirement. Contributions are made directly to an Individual Retirement Account (IRA) set up for each employee (a SEP-IRA).

Employer contributions for each eligible employee must be:

  • Based only on the first $250,000 of compensation
  • The same percentage of compensation for every employee
  • Limited annually to the smaller of $50,000 or 25% of compensation
  • Paid to the employee’s SEP-IRA

An eligible employee (including a self-employed individual who received earned income) is an individual who meets all the following requirements:

  • Has reached age 21
  • Has worked for the employer in at least 3 of the last 5 years
  • Received at least $550 in compensation from the employer during the year (for 2010 and 2011)
  • An employer can use less restrictive participation requirements than those listed, but not more restrictive ones.

SEPs are attractive because they do not require annual discrimination testing or IRS filings. However, this lack of oversight can lead to errors. One of the most common mistakes is the employer’s failure to contribute for eligible employees. Other errors include:

  • Failure to amend or update the SEP plan document
  • Failure to include employees of a related business
  • Errors in the calculation of the contributions due to usage of incorrect definition of compensation
  • Contributions are not a uniform percentage of compensation per participant’s compensation
  • Contributions exceed maximum legal limits

These problems can be corrected by using one of the various IRS correction programs.