What type of plan to set up

In determining which type of plan to set up, you may want to consider how many employees you have, whether all or most of your employees already have an IRA set up, how you want to contribute to your own retirement account, whether your employees would be interested in deferring part of their salaries into a retirement account, how much your business intends to contribute to the employees’ retirement accounts, and how complex it is for your business to set up a particular plan. You should also consider that the different plans have different maximum allowable contributions and different maximum deductions that your business can take for its contributions.

SEP (Simplified Employee Pension)

How to set up a SEP plan

You will need a written plan that allows your business, as the employer, to make contributions toward your own retirement account (as a self-employed individual) and toward all your eligible employees’ retirement accounts. Most banks and other financial institutions can help you with this plan.

For a SEP, the written plan allows your business to make contributions to the financial institution where each eligible employee has his or her IRA. Eligible employees are all individuals who are 21 years of age or older, have worked for you in at least 3 of the last 5 years, and have received at least $450 in compensation. If an employee does not have an IRA, a SEP-IRA can be set up. SEP-IRAs can be set up for employees at banks, insurance companies, or other qualified financial institutions. Roth IRA’s are not eligible to receive contributions from a SEP plan.

You can satisfy the written plan requirement for a SEP by completing IRS Form 5305-SEP. Once you complete this form, you should keep it for your records. It does not need to be filed with the IRS. Form 5305-SEP can be downloaded from the IRS website at www.irs.gov.

Once you complete and sign the written plan, each eligible employee should be given information about the plan. If you use Form 5305-SEP, give each employee a copy.

How much you can contribute to a SEP plan and claim as a deduction

You are not required to make contributions every year, but when you do, the percentage of compensation that you contribute must be the same for all employees, and must not be more than 25% of the employee’s compensation, up to a certain maximum limit. Annual limits on the amount of compensation for which you can make contributions may change from year to year and are published by the IRS.

The contributions you make under a SEP are generally are not taxable to the plan participants. You do not need to report your SEP contributions on the employees’ W-2 statements. But, if you contribute more than the maximum amount allowable, the excess must be included in the employees’s taxable compensation, and you may be subject to a 10% excess tax.

Your business contributions to your own SEP-IRA, as a self-employed individual are also subject to annual limits, but special rules apply. Your deduction for contributions to your own SEP-IRA, as a percentage of your net earnings, and your net earnings themselves, depend on each other. So you have to do a special calculation to determine your maximum deduction. You can do this by completing the Rate Table for Self-Employed or the Rate Worksheet for Self-Employed that can be found in Publication 560 – Retirement Plans for Small Business.