Some employers are still using the Simplified Employee Pension (SEP) plan as the company retirement plan. These plans are relatively easy to set up and maintain as the IRS has an online Form 5305-SEP available to set up a plan. For those that don’t want to use the model IRS version of a SEP document, many investment custodians will provide a streamlined SEP adoption agreement if the assets are maintained at their company. Additionally, there is no annual governmental filing requirement for a SEP plan.
So what is not to like about these plans?
Unfortunately, easy to use also means very few options. There are only employer contributions allowed in a SEP. Employees are not allowed to contribute from their own paychecks into a SEP plan. Only the company is allowed to contribute and take any current year deductions. These employer contributions must be given to all employees who have worked for 3 out of the past 5 years, is over age 21, and who earned at least $600 in compensation during the first year of eligibility. A SEP can be set up to accept participants sooner, and it is common to see plans set up to allow for immediate entry. Because the eligibility requirements only require compensation of $600 or more, it will exclude only the most extreme part-time employees from these plans. The SEP generally has a basic pro-rata type contribution to all eligible employees. This means every eligible employee receives the same contribution percentage. While a prototype SEP is permitted to offer a contribution formula integrated with the social security wage base, the model IRS Form 5305-SEP does not.
Many tax exempt entities use a SEP with success
These tax-exempt entities may want to give all their employees a retirement contribution without the annual accounting fee associated with a more complicated retirement plan. The board of directors may only meet periodically and approve a flat percentage retirement plan contribution to all employees. The tax-exempt company could combine a SEP with an ERISA exempt 403(b) plan to avoid any annual accounting fees related to the retirement benefit to avoid all accounting fees related to a retirement plan.
With SEP, all eligible employees must receive an employer contribution
Some for-profit companies with employees will use a SEP to save on accounting fees. However, by using a SEP, all eligible employees must receive an employer contribution even if they left the company during the calendar year. Because all employees must receive the same benefit, this can be expensive if the owner is trying to maximize their own contribution to the plan. A better retirement plan option for many companies is a profit sharing plan using the “new comparability” formula. Even though a Form 5500 is required each year for a profit sharing plan, which will cause an accounting expense, companies with owners who are at least 10 years older than many of their staff will be able to maximize their retirement contribution with a much smaller mandatory contribution to the staff. For a company with a number of employees this can easily be less annual cash outflow even with the added accounting fees. There is also flexibility to give different contribution amounts to different staff members as long as the minimum amounts are funded to the eligible employees.
With Profit Sharing, Active Employees Only
A profit sharing plan can also have the requirement that employees be employed on the last day of each plan year in order to receive a contribution. The annual accounting fee for a profit sharing plan may actually be less than the amount that would have been allocated as a SEP contribution to a terminated employee(s) for the year. No one wants to pay a retirement contribution to an employee who is no longer working with the company if they don’t have to do it. This is true especially if the employee who is gone left on bad terms.
Encourage your employees to save
Many employers want to encourage their employees to save on their own behalf which cannot be done with a SEP plan. It can be done with an employer sponsored SIMPLE IRA, 403(b) or 401(k) plan. The SIMPLE cannot be combined with any other retirement plan during the calendar year and it has very restrictive employer contributions. The 403(b) can only be used by church, certain public schools, hospitals, or 501(c) tax-exempt entities. That leaves the 401(k) plan to maximize retirement contributions while allowing employees to contribute to the plan as well. This is why many companies use the 401(k) retirement plan with a new comparability profit sharing formula instead of a SEP plan.
In certain circumstances, the SEP is a good inexpensive retirement plan choice. However, in many employer situations there is a better retirement plan design available and it is worthwhile to see a comparison of the current options available. Employers currently using a SEP are likely to benefit from requesting an analysis of their options. Contact our consultants at PBMares to discuss which retirement plan is right for your organization..