Simplifed Employee Pension (SEP) Plan Compliance Traps to Avoid

As the stock market and general business climate continue to present significant challenges on what seems like a daily basis, one of the constants that individuals face is the need to save for their retirement. For business owners who want to help their employees with this effort, and many do—both for their employees’ sake as well as their own, one of the easiest options for doing this is a Simplified Employee Pension (SEP) plan.

SEPs have been around for years and continue to be popular mostly because they’re flexible regarding how much an employer has to put in each year (contributions can be as small as zero in years when a business’ cash flow is tight) and because the rules for setting up and operating a SEP are relatively simple. A SEP can be adopted for a particular year as late as the extended due date of that year’s tax return and, within certain limits, employers can choose how much they contribute to the plan (but generally have to share the contribution equally among all employees on a pro rata basis based on relative salaries).

Despite a SEP’s simplicity, employers can and do at times get themselves in trouble with the operation of their plans. For example, the IRS recently released a list of five common mistakes that employers make when it comes to SEPs:

1. Failing to keep their plan document current—SEPs are generally adopted simply by completing a short IRS Form 5305-SEP (or by completing a financial institution’s prototype plan form). When the IRS issues a new Form 5305-SEP (the most recent is from 2004), employers need to update their plan by completing the new form.

2. Failing to cover all eligible employees—In a recent court case, a SEP failed to qualify because one of two employees (the wife of the president of the company and the only other employee) didn’t receive a contribution under the plan even though she was eligible.

3. Failing to cover eligible employees in related businesses that are under common control.

4. Failing to use the right compensation number for employees when calculating the amount of their contribution.

5. Failing to limit contributions to a particular employee’s account to no more than the maximum allowed (normally the lesser of 25% of covered compensation or, for 2008, $46,000).

For our clients that currently have SEPs, if you have any concerns about whether your plan is meeting all of the eligibility requirements, please call us and we’d be happy to discuss this. If you currently don’t offer a retirement plan, but would like to consider a SEP or another option [such as a SIMPLE IRA or a 401(k) plan], we’re available to discuss that as well.

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