Monday, June 15, 2009

SEPs : Follow the law and everything will be okay

As business owners prepare for the second half of 2009, there are tax planning opportunities that can be advantageous even in the middle of a tax year. One such opportunity is employing a retirement plan for an employee group. I am covering one retirement plan type here, but there will surely be more to follow in the future.

Many employers have heard about SEP plans, and many small businesses use them as a helpful retirement vehicle. SEP stands for simplified employee pension, which allows for employers to contribute amounts to employees’ SEP individual retirement accounts or SEP-IRAs.

SEP plans are usually employed in small businesses as a retirement vehicle for closely held corporations and partnerships in place of traditional IRAs which have lower contribution limits. In 2009 the maximum contribution for a IRA is $5,000 while the maximum contribution for a SEP is limited to the lesser of 25% of compensation (W-2) or $49,000. So you can see the potential upside to contributing larger amounts per year to your retirement plan through a SEP plan.

It is easy to set-up a SEP plan; there are only three general rules to follow. First you have to set-up the plan. Your business can do so by either filling out IRS form 5305-SEP or any other equivalent form provided from a financial institution. Second, you have to provide all employees with a copy of the plan. Last, you have to set-up SEP-IRAs for or by each individual employee.

Once you have the plan set-up you only have to follow two very important rules. One, you have to make substantially equal payments to all employees covered by the plan. For this test note that substantially equal means that contributions can be tied to a percentage of W-2 wages, or you can use the same contribution for all employees. Second, you have to remember to always contribute amounts equally to all covered employees, even if you are husband and wife and you see your compensation as ‘shared’.

Remember that you may be able to restrict the definition of covered employees to exclude those employees that have not completed a time of service restriction, or may be considered part-time or seasonal employees. Beyond these restrictions, the only maintenance a SEP Plan should have after the initial set-up would be verifying that contributions have been made substantially equal to all employees that qualify. If you do these things you should have a very beneficial retirement plan without many of the restrictions imposed by other plans (as long as the stock market doesn’t consume all of your savings J).