SEP Solution?

By Barbara Weltman April 29, 2004
Barbara Weltman Don’t expect Social Security to provide you with a comfortable retirement income. Instead, you must save as much as you can in both tax-advantaged retirement accounts and personal savings (included your business) to underwrite your retirement. Knowing which retirement account to use to meet your goals is the first step in this savings process.

SEP basics

If your goal is to put away as much as you can with as little hassle as possible, using a Simplified Employee Pension (SEP) plan may be for you.

Key features:

  • For 2004, you can deduct contributions up to $41,000, provided your salary or net earnings from self-employment are at least $204,000.

  • You can set up the SEP any time during the year to which it relates and as late as the extended due date of the return. For example, for 2004, you can set up a SEP between January 1, 2004, and October 15, 2005, provided you obtain filing extensions to this date.

  • No annual reporting is required.

    • You no longer have to use a profit-sharing plan or other defined contribution plan to maximize contributions. You can use a SEP and cease contributions to your prior plan. Terminating the prior plan can reduce administrative costs and avoid the need to file annual information returns, but talk with a pension expert before taking any action on an existing plan.

    Important: If you have employees, you must contribute on their behalf. Whatever percentage of compensation you use for yourself you must apply to employees as well. For example, if you contribute the maximum of 25% for yourself, you must contribute 25% for each employee eligible to participate (you can only exclude employees under age 21 and those 21 or older who do not earn at least $450 during the year and have not worked for you in at least three of the five preceding years).

    Advantages and disadvantages of other types of plans

    A SEP isn’t the only solution possible. If you want to save more than the annual SEP limit, you must explore other types of plans.

  • Defined benefit plans let you contribute what is actuarially determined to be required in order to pay promised retirement benefits. The older you are, the larger the deductible contributions you can make. Downside: Administrative costs (for accountants and actuaries); annual reporting required.

  • 401(k) plans let you contribute both as an employer and as an employee, thus increasing your retirement savings. Downside: Annual reporting required.

    • If you have only modest earnings (under about $50,000) and want to maximize annual contributions, a SIMPLE plan (Savings Incentive Match Plan for Employees) may be your choice. Like 401(k) plans, a SIMPLE plan lets you make both employer and employee contributions on your own behalf. A SIMPLE plan is also a good way to minimize your contribution requirements to employee accounts – the burden is shifted to employees to fund their own accounts, with only modest employer contributions required.

    For more details about your retirement plans options, see IRS Publication 560, Retirement Plans for Small Business, at www.irs.gov.

    Category: Financial Planning
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