Setting up a Simplified Employee Pension Plan is one option if you wish to provide a retirement savings vehicle for your employees (SEP). SEPs, on the other hand, don't need to be set up until the end of the plan year, unlike qualified plans, which must. Contrarily, a SEP IRA may be created until the company's tax filing date, including extensions. We'll go over some of the other benefits of SEPs and discuss some of the other considerations you should make before settling on one for your firm.
What is a SEP IRA?
One form of IRA, known as a Simplified Employee Pension (SEP) IRA, allows employers to make contributions on behalf of their workers. There is no limit to the company size or revenue that may set up a SEP since it is a tax-deferred retirement plan. Due to higher contribution limits, more adaptability, and fewer administrative requirements, these retirement plans are often used by self-employed people and small company owners. A SEP IRA may be the appropriate solution if you operate a business without many workers and want a stress-free, flexible method to contribute to retirement.
How SEPs Work
Let's look at an illustration: For an employee to be qualified for a SEP contribution under ABC Inc.'s SEP IRA, they must have worked for the company for a minimum of three of the five years prior to the current year. In 2016, 2017, 2018, as well as 2019, Jane R. worked part-time at ABC Inc. Jane has worked for at least three of the past five years. Therefore she is eligible to receive a contribution in 2020, provided she satisfies all other qualifying conditions. A year of service may be any amount of time for purposes of SEP IRAs; hence, an employee who works for one week in a year is considered to have completed a year of duty.
Higher Contribution Limits
The larger contribution limitations of SEP plans are the primary reason why company owners choose them over standard IRAs and Roth IRAs. In 2019, 2020, and 2021, the maximum contribution to a regular or Roth IRA is $6,000 ($7,000 if over 50). The maximum contribution to a SEP account, however, is the lower of 25% of a participant's annual pay or $58,000. As of the year 2022, this will rise to $61,000.
A person may contribute the maximum to both a regular or Roth IRA and a SEP IRA in the same year. You may max out your conventional or Roth IRA and contribute the maximum of $58,000 (assuming your income is at least $232,000) if you are a small company with a SEP plan in 2022. Instead of saving $6,000 to $7,000 each year for retirement, you can save up to $64,000 or $65,000 with only an IRA.
Reporting Requirements
The only tax information the employer is required to submit is the SEP contribution on the company's tax return. SEP IRA contributions are reported by the IRA custodian or trustee on IRS Form 5498, and distributions are reported on IRS Form 1099-R. It is important for both employers and workers to remember that contributions are reported by custodians in the calendar year in which they were received. The amount reported by ABC Inc. on Form 5498 for 2018 may not match the amount ABC Inc. actually contributed to the SEP for that year if, for example, the company didn't make its 2018 SEP payments until May 2019. As such, it is important for businesses to retain records detailing employee SEP contributions.
Administration Ease and Affordability
SEP IRA schemes require relatively minimal administrative work. The IRS Form 5500 tax filing and yearly non-discrimination testing are annual necessities for other retirement plans, such as 401(k)s. Preparing these kinds of tax returns often entails a high degree of reporting risk on the part of the preparer, and as a result, the annual cost to the taxpayer may easily exceed several thousand dollars.
Benefiting from the SEP IRA's ease of administration is also possible due to the absence of yearly employee reminders. 401(k) plans generally require paperwork such as Safe Harbor Notifications to be provided to each employee by a particular due date each year. Unlike traditional IRA plans, there are often no yearly reporting requirements for SEP IRA plans.
Conclusion
You may find that the SEP IRA's low overhead and ease of management appeal to you, as they do to many other company owners. Although it may be simple to set up the SEP, you should check with a tax expert to be sure that the plan you choose is appropriate for your company's circumstances. If you'd rather have a qualified plan instead of a SEP IRA but missed the time to set one up, you may still set up a SEP IRA and transfer the money to a qualified plan at a later date.
