SEP IRA Rules for Employees

By Shani Valdez

  • Overview

    SEP IRA Rules for Employees
    Simplified Employee Pension plan (SEP) is an alternative low-cost qualified employer retirement plan. Any corporate, partnership, non-profit organization or sole-proprietorship employer may create a SEP under: Form 5305-SEP (IRS model), use a prototype SEP from a financial institution or write up his or her own SEP plan. Contributions will vary for employees and owner-employees. All contributions made are tax-deductible for the employer but will not be subject to tax for the employee until distributions are made from the account. Furthermore, employees are prohibited from making salary-deferred contributions into a SEP plan.
  • Employee eligibility

    Both employees and employers must meet SEP provisional requirements. Employers are able to choose which eligibility requirements are to be used, but generally employees must be at least 21 years of age; must be employed by said employer for a minimum of 3 out of 5 years and must take in at least $500 in yearly compensation. Employers must contribute on behalf of all eligible employees. This requirement is inclusive of all part-time or seasonal employees that did not pass away or get terminated during the year. Employers can vary their yearly contributions from 0 to 25 percent of employee wages (currently cannot exceed $46,000), but must apply the same contribution percentage to all plan participants.
  • Employee distributions

    SEP provisions do not make it permissible for employees to take loans against their retirement plans. However, an employee may distribute funds from the account at anytime. You may rollover SEP assets into a personal IRA or another qualified employer-sponsored retirement plan (check plan provisions to be sure the other qualified plan takes rollover contributions). If distributions are taken prematurely, your distribution will be subject to ordinary income tax and a 10 percent penalty if funds are withdrawn before age 59 1/2.

  • Sole-proprietors

    SEP provisions allow owner-employees to contribute funds in a SEP plan. 20 percent of adjusted net profit (net profit - self-employment tax = 92.935225 percent of net profit), equating to 18.587045 percent of your net profit that is permitted for contributions. Publication 560 references this computation and should be carefully reviewed. Contribution amounts are always subject to change so be sure to check SEP provisions yearly.

    The Salary Deferral SEP (SARSEP) plan is no longer available to employers; however, employers who established a SARSEP prior to January 1, 1997, may maintain their SARSEP account. Employees can make salary-reduced contributions to their SARSEP of up to $15,500 in addition to COLA increases. Employees aged 50 or older may contribute catch-up contributions to their account of $5,000 in addition to COLA increases as well. Employees should check with their employers, as there are provisions that may reduce their SARSEP contribution limit.
  • Considerations

    A traditional IRA must be set up at a financial institution before SEP IRA contributions can be established. However, some institutions will require the account to be coded as a SEP IRA instead of a traditional IRA before contributions are accepted. Deposited SEP contributions are considered traditional IRA assets after money is invested; therefore, traditional IRA distribution and investment rules will apply to SEP plans. Since the SEP is established in a traditional IRA vehicle, employees are able to make personal IRA contributions into the same account. Furthermore, all employer-made contributions are 100 percent vested.
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