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You are eligible for a SEP is you are self-employed, or if you are an employer and want to contribute to your employee’s retirement without getting involved in a more complex qualified plan.
There are three basic steps to setting up a SEP.
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Execute a formal written agreement to all eligible employees; |
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Each employee is given certain information on a SEP including a 5305-SEP form. |
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A SEP-IRA must be set up for each eligible employee. |
The deadline to set-up a SEP is as late as the due date of your income tax return for that year.
A SEP Rules permits you to contribute a limited amount of money
each year to each employee’s SEP-IRA. Self-employed individuals
can contribute to their own SEP-IRA. Cash, check or money orders
can be used as contributions. You cannot contribute property,
unless you transfer or roll property (stocks, bonds, mutual funds,
partnerships, real estate etc.) from one retirement plan to another.
Contributions do not need to be made each year, but each contribution
must be based on a written allocation formula and should not
discriminate in favor of highly compensated employees. The contributions
are treated as if made to qualified pension, stock, bonus or
annuity plans. So, they are deductible and are generally not
taxable.
Contributions
cannot exceed the lesser of 25% of the employee’s compensation
or $44,000 for 2006 and $45,000 for 2007 (and then subject to
annual cost-of-living adjustments for later years).
An amount paid to participants from a qualified plan is called a distribution. Distributions may be non-periodic or lump sum. They can also be periodic such as annuity payments or certain loans. See IRS Publication 575 (Link to Publications) for more information. A qualified plan must provide that each participant will receive their entire interest in the plan by the required beginning date or regular periodic distributions. These distributions rules apply to each qualified plan. That means that you cannot take a distribution from one plan to apply for another.
If the account balance is to be distributed, the plan administrator must figure the minimum amount required to be distributed each calendar year. This is figured by dividing the account balance by the appropriate life expectancy. Distributions must also meet the minimum distribution incidental benefit requirement. Which means, the plan is used to provide retirement benefits to the employee. After an employee passes away, only incidental benefits can remain for the distribution to the employee’s beneficiary. The required distribution date from a qualified plan is the calendar year in which he or she reaches 70 1/2or the year he or she retires with the employer maintaining the plan.
Distributions from a qualified plan, minus a prorated part of the costs basis (if applicable), are subject to tax in the year the distribution takes place. In few instances, does a participant have cost basis. An exception is a rollover in a traditional IRA or eligible retirement plan. An eligible rollover is not any of the following:
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A required minimum distribution; |
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A series of equal payments made at least once a year over the employees life expectancy, the joint lives of the employee and beneficiary or a period of 10 years; |
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Hardship distribution; |
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A portion that represents the employee’s nondeductible contributions; |
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A corrective distribution; |
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Loans; |
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Dividends; or |
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The cost of insurance coverage. . |
If a participant is expected to receive $200 or more from a plan, the payer must withhold 20% for federal income tax. If the participant chooses instead to have the plan pay it to an IRA or another eligible plan, no withholding is required. If no income tax is withheld and no rollover occurs, the recipient may have to make estimated tax payments.
There is a 10% early withdrawal tax if there are distributions before the age of 59 ½ unless the following circumstances prevail:
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A beneficiary receives the funds when the employee passes away. |
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A qualifying disability for the employee. |
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It is a part of a series of equal periodic payments after separation of service, at least annually, for the life expectancy of the employee or their designated beneficiary. |
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If it is made during separation of service when the employee reaches 55. |
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A domestic relations order. |
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For the employee as a medical expense deduction. |
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To reduce excess contributions. |
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To reduce employee or matching employer contribution. |
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To reduce deferrals. |
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An IRS Levy. |
To report the tax on early distributions, file Form 5329.
For more information, consult the Department of Treasury, Internal Revenue Service Publication 560 Retirement Plans For Small Businesses listed under Publications. |
