Small Business Retirement Plans Part 3: The SEP Plan
Over the past two weeks, we’ve discussed two different types of retirement plans for small business owners: the SIMPLE IRA and the Solo 401k. To wrap up this month’s series on small business retirement plans, I want to look at the Simplified Employee Pension Plan, or the SEP.
Simplified Employee Pension (SEP) plans can provide a significant source of income at retirement by allowing employers to set aside money for themselves and their employees. A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25% of each employee’s pay. The good news is that any size business (even a business of one) can open a SEP plan and there are no annual filing requirements which can save time and money.
So How Does a SEP Work?
To illustrate how the SEP works, let’s look at an example.
Jed works for the Rambling RV Company. Rambling RV decides to establish a SEP for its employees. Rambling RV has chosen a SEP because the RV industry is cyclical in nature, with good times and down times. In good years, Rambling RV can make larger contributions for its employees and in down times it can reduce the amount. Rambling RV’s contribution rate (whether large or small) must be uniform for all employees.
The financial institution that Rambling RV has chosen for its SEP has several investment funds from which to choose. Jed decides to divide the contribution to his SEP-IRA among three of the available funds. Jed, an employee, cannot contribute because SEPs only permit employer contributions.
I especially like the SEP plan for single owner businesses (need to closely compare SEP and Solo 401(k)) or businesses that will have cyclical cash flow because there are no annual requirements for contribution or matching.
SEP Contribution Limits
For 2015, contributions to an employee’s SEP-IRA cannot exceed the lesser of:
- 25% of the employee’s compensation or
- $53,000
One of the nice features of this plan is that you can be fairly exclusive of new employees especially if you own a seasonal business or have a business which generally has higher turnover.
An eligible employee (including a self-employed individual who received earned income) is an individual who meets all the following requirements:
Plan Requirements
- Has reached age 21
- Has worked for you in at least 3 of the last 5 years
- Received at least $550 in compensation for 2014 ($600 for 2015)
Pros Of The SEP Plan
- Easy to set up and easy to administer
- You can set up a plan up to the time you file your taxes
- Flexible annual contributions
- Wide array of investment choices
- Employees can defer income
Cons Of The SEP Plan
- Immediate vesting schedule
- Mandatory to contribute to employees when you contribute for the owner
- Owner must make contributions equal from a percentage perspective
Regardless of the type of plan you choose to create for your business, I always recommend consulting a professional. Offering a great retirement plan is a good way to keep your best employees in the business and attract great new talent. For more on small business retirement plans, be sure to revisit the previous two articles of this series:
Small Business Retirement Plans Part 1: The SIMPLE IRA
Small Business Retirement Plans Part 2: The Solo 401k
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