Simplified Employee Pensions

Simplified employee pension plans are designed to allow employers who cannot afford the expense and effort of complying with the rules governing qualified employee pension benefit plans to provide pension benefits comparable to those of qualified plans. The SEP provisions allow employers to contribute amounts to the individual retirement account (IRA) of each of their employees that exceed the normal limits on deductions for employee contributions to an IRA. One advantage associated with SEPs is their simplicity. In many cases, an employer can establish a SEP by completing a one-page IRS form. On the other hand, the price of a SEP’s simplicity is its inflexibility. Nevertheless, many small employers use SEPs as a retirement plan for purposes of attracting and retaining valuable employees. This chapter discusses the rules associated with the implementation and maintenance of SEPs.

Sole proprietorships and partnerships can establish SEPs. The sole proprietor is treated as his own employer and the partnership is treated as the employer of each partner.

An employer may establish a SEP using Form 5305-SEP. This form may be used in connection with the model IRA or a master or prototype IRA for which the IRS has issued a favorable opinion letter. Form 5305-SEP may be used only by an employer that:

  • does not maintain any other qualified plan;
  • has never maintained a defined benefit plan;
  • establishes IRAs for all eligible employees;
  • does not use leased employees;
  • is not a member of an affiliated service group, a controlled group, or a trade or business under common control, unless all eligible employees of all members of the affiliated or controlled group participate in the SEP; or
  • will not pay the cost of SEP

Both the SEP and the IRAs must be amended to reflect changes made in 2017, including increased contribution limits. For 2017 the SEP IRA Contribution limit is the lesser of 25% of compensation, or $54,000.

An employer may also establish a SEP using a prototype SEP arrangement that has been approved by the IRS national office. Banks, credit unions, savings and loans, insurance companies, regulated investment companies, or trade or professional societies or associations may sponsor a prototype SEP. A favorable opinion letter for that SEP may be requested on Form 5306-A, Application for Approval of Prototype Simplified Employee Pension (SEP) or Savings Incentive Match Plan for Employees of Small Employers (SIMPLE IRA Plan).

An employer may also prepare an individually designed SEP and obtain a ruling from the IRS national office that the arrangement satisfies the requirements of Code Section 408(k). Rev. Proc. 87-50, 1987-2 C.B. 647.

An employer might consider adopting an individually designed SEP if it is ineligible to use Form 5305-SEP or if it can rely upon the opinion letter of a prototype SEP.

The IRS requires that SEP contributions under an individually designed SEP arrangement be made only through a model IRA (Form 5305 and Form 5305-A) or master or prototype IRAs.