Simplified Employee Pension Plan – A Detailed Guide

In today’s competitive world, a simplified employee pension plan has become an effective way to offer attractive retirement benefits. Moreover, beyond the benefits for employees, it also provides significant tax advantages to employers.

Most importantly, with this plan, business owners and self-employed individuals will have the privilege of easing off administrative burdens and enjoy flexibility in their contributions.  This article further explains all you need to know so, read through.

What is a Simplified Employee Pension Plan (SEP)?

It’s a pension plan that allows an employer or self-employed individual to contribute to an individual retirement account (IRA) or annuity set up for each plan participant.

Furthermore, the money invested in this account grows either tax-free or tax differed depending on your account type and your eligibility to own an account once you begin to earn income. The account is opened through a bank, a robo adviser or a broker.

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Benefits of a Simplified Employee Pension Plan (SEP)

• As an employer, you can make flexible contributions each year and may decide to skip between yearly payments.
• Taxation is not included during your contributions except at the time of withdrawal.
• You can create the fund for yourself and your employee as an employer.
• It’s a low-budget option with an easy operation system
• There are absolutely no filing requirements needed.

Disadvantages

• No contribution of money to the Simplified employee pension plan post taxes, unlike the Roth 401(k) plan
• As an employer, you must contribute equally to all the pension funds you created for your employees, including yourself.
• Loans or Roth contributions are not permitted
• People aged 50 and above are not permitted to make catch-up contributions to increase the available money in the account.

Eligibility requirements

To be eligible for this plan as an employee or self-employed individual:

• You must be at least 21years old and above
• You must have worked for not less than 3years in the organization
• You must have received payment of at least $650

The employee can relax some of the above-listed eligibility criteria with the following exclusion;

• Those who get retirement benefits by being union members.
• Those considered non-resident aliens who had never received compensation from their employer for the first time.

Procedures for setting up a Simplified Employee Pension Plan account

The first criterion is to be self-employed or a small business owner who wants to secure a retirement option for your friend or employee. Next, set up the plan by filing form 5305-SP or its prototype. Then, choose a financial institution or a broker to set up the account.

How to make contributions

To maintain the account, you must contribute to fund it before the due date for filing your income tax for the year. As an employee, you can make personal investment decisions.

You may need to conduct an annual check on your account to ensure it operates with the rules.

The Contribution Limit

Employers could contribute 25% of their annual salary to each employee’s plan. You can equally contribute to your plan as an individual, but to determine the actual amount to contribute, you must:

• Know your net profit
• Deduct your reduced self-employed tax from your net profit
• Multiply your tax deduction by 0.50
• Multiply your new net profit by your reduced plan contribution rate and then contribute your total.

Note that you will need to contribute to the fund before the due date of your income tax return for the year. You will also have to conduct an annual check-up to ensure you stay up to date with the rules.

You can withdraw from the account at any time, but it must be subject to the restrictions imposed on the traditional IRA. You can also rollover your tax-free contribution made under the SEP to another retirement plan. You will pay tax while withdrawing the contributed amount.

Conclusion

The simplified pension plan is a good way to defer taxes and your pension fund to secure your finances after retirement. This savings option empowers businesses to offer equal contributions to employee accounts. Informed consideration of the pros and cons above will guide you to determine whether or not it aligns with your saving goals.