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Simplified Employee Pensions gain popularity
by Tony Novak, CPA, MBA, MT
,last updated on 12/1/2011
Simplified Employee Pensions (known as SEPs) have gained in popularity this year among small business owners after a liberalization of tax laws in late 2001. Generally, it takes a couple of years for new tax incentives to be digested by advisers and adapted by businesses. This seems to be the case this year, as self-employed individuals focus on the new tax benefits and open SEP plans in record numbers. Freedom Benefits Association, a online resource for small business benefit plans, has recorded more inquiries for advice about SEP plan startups this year than all 401(k), SIMPLE and other small business retirement plans combined.
There are several advantages to SEPs contributing to their growing popularity:
1) The maximum allowable tax-deductible contribution has been increased to 25% of earnings up to a maximum annual contribution of $40,000. This is a substantially larger tax break than the old limits allowed, and this makes the SEP more attractive to high-income individuals.
2) SEPs cost very little to set up and administer. The only significant cost to starting a SEP plan is the discretionary cost of hiring a financial adviser or benefits enroller for an hour or two to answer employee questions and help with the paperwork. If you do incur any significant charge for the plan setup, the IRS reimburses you with a 50% tax credit for the start-up cost up to $500 per year.
3) Business owners have significant control over who is included or excluded from benefits under the retirement plan. Even though SEP plans do have non-discrimination rules established by the IRS, these plans offer the business owner wider latitude in establishing eligibility rules, as compared with 401(k) or other small business retirement plans.
4) Investment accounts can be opened using no-load mutual funds without commissions for as little as $250. Many fund families drop their minimum initial investment and fees for clients working with a non-commissioned financial adviser. This makes these SEP plans popular for those just starting out with a retirement savings plan.
5) SEP plans can be established retroactively for the previous tax year. Individuals who filed for extensions on their 2002 tax return, for example, could open a SEP on July 15, 2003 and still take the tax deduction for 2002.
6) Administration is simple. SEPs require written plan documents like all other tax-qualified retirement plans, but the documentation is significantly easier. Similarly, the ongoing administration is likely to take about an hour each year in order to ensure ongoing tax compliance and maintain good employee communications about the benefit plan.
7) Employees own the investment accounts entirely in their own name. This translates into lower costs, less paperwork and responsibility and a much lower threshold of legal liability for sponsoring employers than 401(k) plans or profit-sharing plans. Once the tax-deductible deposit is made to the employee’s account the employer’s responsibility ends.
8) The employer’s contribution can be scaled back during lean years and increased during profitable years.
9) The “simplified” feature in “Simplified Employee Pension” means that the plans can be started with just a phone call to a financial adviser or financial institution.
Disadvantages of SEPs
The two primary drawbacks of SEP plans are:
1) loans are not permitted; and
2) contributions are made by the employer only, not by both the employer and employee as in a 401(k) plan. Unlike 401(k) plans, SEPs do not allow voluntary employee contributions.
The IRS updated its library of SEP plan resources in July 2003 at www.irs.gov. Just type “SEP” in the site search button to reveal a handful of useful documents. Other resources including “Frequently asked Questions About Starting a SEP Plan” and “SEP Small Business Administration Guide” are both available at www.FreedomBenefits.org.
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