Simplified Employee Pension Plans Part 2: SEP Contributions & Distributions
In Part 1 we discussed the definition, eligibility and setup of a Simplified Employee Pension Plan. Now that you have some understanding of SEP’s, we’re going to take a look at contributions into and distributions out of the plan.
Contributions are made on a discretionary basis by the employer. Contributions should be made to the trustee for the eligible employees. The trustee has the responsibility of depositing the funds contributed into the investment pool of the specified employees. They are also responsible for creating and sending out the annual report showing contributions made and account value.
Contributions are limited to 25% of employee’s annual compensation or $53,000 (2015), whichever figure is lower. Uniform contributions must be made to all employees who performed work during the year during the year for the employer administering the plan. This includes any terminated or deceased employees that worked in the contribution year.
These contributions are due by the entity’s tax filing deadline (including extensions), and they are generally tax-deductible for the employer. This is a tool that you should be taken advantage of for tax planning purposes. My employers choose to hold off on their contributions until after year end is wrapped up, and then they can adjust their tax liability by making a more calculated contribution. This flexibility to make a contribution after year end is another great advantage of a SEP.
Since the total amount of contributed funds is always considered 100% vested to employees, they may take distributions at any time. Distributions are generally taxed at the applicable income tax rate at the time of withdrawal. However, if these distributions are taken before the age of 59.5, there can be an additional 10% penalty applied. There are a number of instances in which the 10% penalty can be avoid if the funds are taken before 59.5 and the funds are used for one the following circumstances:
- Unreimbursed medical expenses
- Disability Needs
- Distribution to the Beneficiary of the Plan
- Qualified higher education expenses
- For the purchase of the first home
- IRS levy payment
If no distributions are taken up until the age of 70.5, the required minimum distribution rule comes into play. The RMD amount is based on a calculation of age and value of the plan. The IRS provides a RMD calculator.
After reading this article, I’m sure you have a better understand of what makes up a SEP plan and how they’re run. Maybe this helps spark your interest in establishing one, and you’re ready to start. Please feel free to contact Anders with any questions.