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SEP: Retirement Planning Made Easy

The retirement plan dilemma: Either bear the expense of trying to comply with the federal regulation of a formal pension plan — or get taxed supplementing the $4,000 maximum annual contribution (and, if over age 50, an extra catch-up of $500) to an IRA, for 2005. There is, however, a third choice. It's called a SEP — for Simplified Employee Pension — and it was designed with the small business owner in mind. Best of all, it's easy to set up and requires only a minimum amount of administration.

It's no secret that a qualified pension or profit sharing plan can be costly and administratively burdensome. It can require hours of costly bookkeeping in an attempt to meet the federal government's rigorous compliance and record keeping requirements.

The Simplified Employee Pension is an attractive alternative. SEPs are hybrid plans that combine the high contribution limits of a more formal plan with the simplicity of an IRA. As an employer-sponsored retirement plan, a SEP can be established by a sole proprietor, partnership, or corporation.

The best part about a SEP: You can save taxes today while building a retirement fund for tomorrow — all with a minimum of administrative cost and paperwork. IRS Form 5305-SEP is all that is needed and the form is not required to be sent to the IRS.

Here are the Basics of a SEP

  • Generally, you can make contributions of up to $42,000 a year or 100 percent of compensation (up to a maximum of $210,000 of compensation, in 2005), whichever is lower. Example: If you earned $100,000 this year, you can contribute up to $42,000(annual contribution limit for 2005) to your SEP. If you earned $40,000 this year, you can contribute up to $40,000 (100% of compensation) to your SEP. (Click here for a table of increasing annual contribution and compensation limits)
  • It can serve as a free-standing retirement plan, provided contribution limitations and other restrictions are met. In this respect, a SEP provides a great deal of flexibility for the business owner.
  • Contributions are tax-deductible by the employer and not included as income by the participant. Also, as with other qualified plans, all earnings are tax deferred until the funds are received.
  • There are a number of funding vehicles available. Essentially, the options are identical to those allowed for IRAs. In fact, the employer (and this includes contributions made by the self-employed, sole proprietors, and partners on their own behalf) simply makes contributions to an IRA established by the employee. If the participant already has an IRA, it is not necessary to establish a new account. Funding vehicles include annuities, mutual funds, and certificates of deposit.

In most cases, there are no installation costs, since the requirements for establishing a SEP are minimal. You must prepare a plan document and give notice of the plan to all eligible employees. Most employers can use IRS form 5305 to establish a model SEP. Non-model SEPs require special documents to add such features as Social Security integration. Fortunately, SEPs have been around since 1979, so there are non-model plan documents readily available. One can easily be adapted for your needs.

Ongoing administration costs and reporting requirements are minimal. For example, no annual reports need be filed with the IRS. Nor must employees be furnished with annual reports, plan summaries or other documents.

To view chart,

Years to Retirement




























*For illustrative purposes only. This is not indicative of the actual performance of any particular product.

All investment decisions are the responsibility of the employee. The employer, in general, bears no fiduciary responsibilities with respect to investments.

  • All funds (including employer contributions) are immediately vested and may be withdrawn by the employee at any time or rolled over to another plan. However, if the employee is under 59½, withdrawals will usually be subject to a 10% federal excise penalty.
  • Unlike some qualified plans, no loans are permitted with SEPs. A loan results in immediate disqualification of the entire account and immediate taxation.
  • Thanks to compounding interest, you can end up with a tidy sum waiting for you at retirement.

How Funds Accumulate in a SEP
A self-employed person generally can contribute the lesser of $24,000 or 15 percent of income to a SEP each year and deduct the entire amount. Here is how $10,000 in annual contributions will look, principal and interest, rounded to the nearest hundred dollars, based on several average rates of return. Any fees, charges, or taxes have not been included in the illustration.

Caution: If you have employees, they generally must be included in the plan. Also, withdrawals are subject to the same limits, restrictions and penalties as IRAs — possible 10 percent penalty, plus current income taxes.

Is a Simplified Employee Pension right for your business? Perhaps. It's certainly worthwhile to find out more.


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