The Easy Steps to SEP IRAs

September 14, 2017 1:48 PM
By Brian Dobbis

Sole proprietors and small-business owners who have an extension of their tax-filing deadline can fund such plans as late as October 16.


For sole proprietors and small-business owners who missed the December 31st deadline to establish a qualified retirement plan for 2016, there is still time to set up a Simplified Employee Pension [SEP] IRA and claim the tax deduction for the 2016 tax year. In addition, those who do so will be helping themselves and their employees save for retirement on tax-advantaged basis.

SEP IRAs were designed to provide self-employed individuals and small-business owners with the ability to save for retirement on a tax-deferred basis. They also may appeal to business owners who want to help their employees save, but who do not want the administrative and fiduciary responsibilities of a qualified plan, such as a 401(k). Instead, SEP IRAs are low-cost, surprisingly easy to set up and maintain, and allow the plan sponsor (owner) to make discretionary contribution, based on the fortunes of his/her business.

For business owners, the contributions they make to their own and to each eligible employee’s SEP IRA account generally are fully deductible by the business. (For sole proprietors, deductions may vary based on the business owner’s net earnings and self-employment tax deduction.)

SEP IRAs can be established and funded as late as the businesses’ tax-filing deadline plus extension (typically six months). For example, sole proprietors had at least until April 15 to establish a SEP IRA for 2016, but if they are on extension, they have as late as October 16, 2017 (October 15 falls on a Sunday).

SEPs are funded solely with the discretionary contributions made by an employer. Contribution limits are generous, allowing an owner to shelter and potentially deduct 25% of compensation or $54,000 (whichever is less) in 2017 ($53,000 for 2016). The percentage is reduced to 20% for business owners who are self-employed. Although SEP contributions are discretionary, they must be based on a written allocation formula, and every employee must be permitted the same rate of contribution. Further, all contributions must be fully and immediately vested upon receipt. Employees are not permitted to defer any of their compensation.

Contributions an employer can make to an employee's SEP IRA cannot exceed the lesser of:

1.   25% of the employee's compensation, or

2.   $53,000 for 2016, $54,000 for 2017.

Tip: Receiving a SEP allocation does not affect traditional/Roth IRA limits. In other words, owning a SEP IRA does not preclude an eligible employee’s ability to fully fund a separate traditional or Roth IRA.

Tip: All SEP contributions must be deposited to a traditional IRA established by the employee. SEP contributions cannot be contributed to a Roth or SIMPLE IRA.

Employer Liability
Unlike employers who offer qualified plans, such as 401(k)s, employers who offer SEPs have a reduced fiduciary obligation to provide workers with assistance in investment planning.

Employers simply report SEP contributions on the business’ tax return. For individual participants, the IRA custodian reports SEP IRA contributions on IRS Form 5498 and distributions on IRS Form 1099-R. Keep in mind that the custodians report contributions in the year they are received. If an employer makes a 2016 contribution in 2017, the amounts reported by employees on their individual returns may not coincide with the employer’s filing. Employers are advised to keep their own records of SEP contributions.

Establishing a SEP IRA is straightforward. In most cases, the employer completes IRS Form 5305-SEP, while eligible employees establish their own SEP IRA account. Employees generally are eligible to participate if they are at least 21, worked for the business in three of the last five years, and received at least $600 in compensation from their employer during the year. An employer can use less restrictive participation requirements than those listed, but not more restrictive.

Employer Eligibility
Virtually any type and size of employer can establish a SEP IRA, including corporations, partnerships, self-employed, LLCs, and nonprofit organizations. If an employer establishes a SEP by using Form 5305-SEP, the IRS requires that the SEP be the only retirement plan offered by the business.

Tip: Take caution when you and/or certain family members own a related business, as SEPs are subject to controlled-group rules. If you or family members own a controlling interest in another business, employees of that other business may need to be included in the SEP, assuming eligibility rules are satisfied.

Employee Notification
The business owner is required to make certain notifications to the employees within a reasonable time after the establishment of the plan. Among other things, the employer must notify employees that a retirement plan has been established, what the eligibility rules are, and how the SEP contribution will be calculated and allocated.

Tip: These requirements, assuming you establish your SEP using IRS Form 5305-SEP, can be satisfied with a copy of Form 5305.


  • The immediate vesting that is required means employees can withdraw the contributions immediately. It also removes a potential retention tool from employers, who cannot set a date in the future for vesting.
  • Loans are not permitted. Unlike qualified plans, SEPs, like all IRAs, do not have a loan feature.
  • The mandated employee eligibility requirements mean that employees who work as little as one day in a year are qualified to participate. This can prove burdensome, especially to businesses that routinely hire part-time or seasonal employees.

While SEP IRAs offer some attractive features, including ease of use and cost-effectiveness, business owners are urged to consult with their tax professionals to make sure that a SEP is the most appropriate choice. It should be noted that businesses that fund SEPs now may roll over the balance to a qualified plan that is established later, if they so decide.

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