The Self Directed SEP IRA may be the most powerful version of the Self-Directed IRA because of the potential for very high annual contributions. Indeed, the SEP IRA can accommodate maximum contributions of well over $50,000 per year in some cases. But the SEP is not a salary deferral plan as much as a profit sharing plan, and thus contributions are more complicated than with standard IRA’s or 401k’s…
A self directed SEP plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a self-directed SEP.
Choosing a Self Directed SEP Plan
Self Directed Simplified Employee Pension (SEP) plans can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. A self directed SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee’s pay.
- Available to any size business
- Easily established by adopting Form 5305-SEP, a SEP prototype or an individually designed plan document
- If Form 5305-SEP is used, cannot have any other retirement plan (except another SEP)
- No filing requirement for the employer
- Only the employer contributes
- To traditional IRAs (SEP-IRAs) set up for each eligible employee
- Employee is always 100% vested in (or, has ownership of) all SEP-IRA money
How does a SEP work?
Jed works for the Rambling RV Company. Rambling RV decides to establish a SEP for its employees. Rambling RV has chosen a SEP because the RV industry is cyclical in nature, with good times and down times. In good years, Rambling RV can make larger contributions for its employees and in down times it can reduce the amount. Rambling RV’s contribution rate (whether large or small) must be uniform for all employees. The financial institution that Rambling RV has chosen for its SEP has several investment funds from which to choose. Jed decides to divide the contribution to his SEP-IRA among three of the available funds. Jed, an employee, cannot contribute because SEPs only permit employer contributions.
Pros and Cons:
- Easy to set up and operate
- Low administrative costs
- Flexible annual contributions – good plan if cash flow is an issue
- Employer must contribute equally for all eligible employees
Who Contributes: Employer contributions only
Contributions an employer can make to an employee's SEP-IRA cannot exceed the lesser of:
- 25% of the employee's compensation, or
- $53,000 (for 2015 and 2016, $54,000 for 2017)
Note: Elective salary deferrals and catch-up contributions are not permitted in SEP plans.
An employer generally has no filing requirements.
Not permitted. The assets may not be used as collateral.
Yes, but includible in income and subject to a 10% additional tax if under age 59 1/2.
Establishing a Self Directed SEP
The first action you'll need to take is to choose a financial institution to serve as trustee of the SEP-IRAs that will hold each employee's retirement plan assets. These accounts will receive the contributions you make to the plan.
Set-up steps for a Self Directed SEP
There are three steps to establishing a Self DIrected SEP.
- Execute a written agreement to provide benefits to all eligible employees.
- Give employees certain information about the agreement.
- Set up an IRA account for each employee.
The written agreement must include the name of the employer, the requirements for employee participation, the signature of a responsible official and a definite allocation formula.
The IRS has a model SEP plan document, Form 5305-SEP, Simplified Employee Pension – Individual Retirement Accounts Contribution Agreement. Do not file this form with the IRS.
You may not use Form 5305 – SEP if you:
- Maintain any other qualified plan (except another SEP – a plan is “maintained” even if no contributions were made during the year),
- Use the services of leased employees,
- Want a plan year other than the calendar year, or
- Want an allocation formula that takes into account Social Security contributions you made for your employees.
If you can't use the Form 5305-SEP, you may use a prototype document. A mutual fund, insurance company, bank or other qualified institution usually provides these. You may also have a SEP individually designed for your business.
Provide information to participants
You must furnish your eligible employees:
- Notice that you have adopted the SEP
- Requirements for receiving an allocation
- The basis on which the employer contribution will be allocated
If you use Form 5305-SEP, you must give your employees a copy of the form and its instructions. The model SEP is not considered adopted until each employee is provided with the following information:
- A statement that IRAs other than the one the employer contributes to may provide different rates of return and contain different terms.
- A statement that the administrator of the SEP will provide a copy of any amendments within 30 days of the effective date along with a written explanation of its effects.
- The administrator will give written notification to the participant of any employer contributions made to a participant's IRA by January 31 of the following year.
If you use a prototype or individually designed plan you must give all eligible employees similar information.
Set up a SEP-IRA for each employee
A SEP-IRA must be set up by or for each eligible employee. They may be set up with banks, insurance companies or other qualified financial institutions. All SEP contributions must go to traditional IRAs. Employees are responsible for making investment decisions about their SEP-IRA accounts.
You and your employees will receive a statement from the financial institutions investing your SEP contributions both at the time you make the first SEP contributions and at least once a year after that. Each institution must provide a plain-language explanation of any fees and commissions it imposes on SEP assets withdrawn before the expiration of a specified period of time.
Timing of setting up a SEP plan
You can set up a SEP for a year as late as the due date (including extensions) of your business income tax return for the year you want to establish the plan.
Who Can Participate in a Self Directed SEP Plan?
An eligible employee is an individual (including a self-employed individual) who meets all the following requirements:
Has reached age 21
Has worked for the employer in at least 3 of the last 5 years
Received at least $600 in compensation from the employer during the year (for 2015, 2016 and 2017)
An employer can use less restrictive participation requirements than those listed, but not more restrictive ones.
An employer can exclude the following employees from a SEP:
Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and the employer
Nonresident alien employees who do not have U.S. wages, salaries or other personal services compensation from the employer
Example 1: Employer X maintains a calendar year SEP. The eligibility requirements under the SEP are: an employee must perform service in at least three of the immediately preceding five years, reach age 21 and earn the minimum amount of compensation during the current year. Bob worked for Employer X during his summer breaks from school in 2013, 2014 and 2015, but never more than 34 days in any year. In July 2016, Bob turned 21. In August 2016, Bob began working for Employer X on a full-time basis, earning $30,000 in 2016. Bob is an eligible employee in 2016 because he has met the minimum age requirement, has worked for Employer X in three of the five preceding years and has met the minimum compensation requirement for 2016.
Example 2: Employer Y writes its SEP plan to provide for immediate participation regardless of age, service or compensation. John is age 18 and began working part-time for Employer Y in 2016. John is an eligible employee for 2016.
Contributions, withdrawals and benefits of saving
Operating a Self Directed SEP
Generally, any employee who is at least age 21 and performed services for your business in three of the last five years is eligible to participant in the employer's SEP plan. Learn more.
What are the contribution rules?
Employer contributions for each eligible employee must be:
- Based only on the first $270,000 of compensation for 2017 ($265,000 for 2015 and 2016)
- The same percentage of compensation for every employee
- Limited annually to the smaller of $54,000 for 2017 ($53,000 for 2015 and 2016) or 25% of compensation
- Paid to the employee’s SEP-IRA
In plan operation, you must follow the definition of compensation stated in the document. Compensation generally includes the pay a participant received from you for personal services for a year.
Special computations for self-employed individuals. When figuring the contribution for your own SEP-IRA, compensation is your net earnings from self-employment, less the following deductions:
- one-half of your self-employment tax and
- contributions to your own SEP-IRA.
For more information on the deduction limitations for self-employed individuals, see Publication 560.
You do not have to contribute every year. When you contribute, you must contribute to the SEP-IRAs of all participants who actually performed personal services during the year for which the contributions are made, even employees who die or terminate employment before the contributions are made.
See the SEP Fix-It Guide for additional information on contribution rules and other information on avoiding common problems in operating a SEP.
When and where are contributions made?
Employer contributions must be made by the due date (including extensions) for filing your federal income tax return for the year.
You can deduct your contributions and your employees can exclude these contributions from their gross income. SEP contributions are not subject to federal income tax withholding, social security, Medicare and federal unemployment (FUTA) taxes.
After you send the SEP contributions to the financial institution you selected, that institution will manage the funds. Employees can move their SEP-IRA assets from one traditional IRA to another. SEP contributions can be put into stocks, mutual funds, money market funds, savings accounts and other similar types of investments. Each employee makes the investment decisions for his or her own account.
Who owns SEP contributions?
Contributions to SEP accounts are always 100 percent vested, or owned, by the employee.
What are the basic withdrawal rules?
SEP contributions and earnings are held in SEP-IRAs and can be withdrawn at any time, subject to the general limitations imposed on traditional IRAs. A withdrawal is taxable in the year received. If a participant makes a withdrawal before age 59½, generally a 10% additional tax applies. SEP contributions and earnings may be rolled over tax-free to other IRAs and retirement plans.
SEP contributions and earnings must eventually be distributed following the IRA required minimum distribution rules.
Participant loans are not permitted.
You may roll over your self directed SEP-IRA into most IRAs and qualified plans.
What are the filing and notice requirements?
Filing requirements: Generally, the employer has no filing requirements, including the Form 5500 return.
Notice requirements: Employers must provide employees:
- a copy of Form 5305-SEP (or the prototype document) and the other documents and disclosures listed in its instructions.
- notice of any amendments to the SEP and the requirements for receiving contributions.
- an annual contribution statement.
How can I tell if my plan is operating within the rules?
You should conduct an annual check-up to help determine whether your SEP plan is operating within the rules. Checklists and tips are available to help with periodic reviews of your plan.
What are the consequences of making a mistake in operating my plan?
Generally, if the SEP fails to satisfy its legal requirements, tax benefits can be lost. However, any error can likely be corrected by using one of the IRS correction programs.
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About The Author
I am host of Self Directed Investor Talk, which I’m told is America’s #1 podcast and for affluent self-directed investors. I’m also something of an expert in self-directed IRA’s, solo 401k’s and 1031 exchanges. You can find more of my writing in some cool places like TheStreet.com, Entrepreneur.com, ThinkRealty and even Forbes (that was always one of my goals!). I live in metro Atlanta, Georgia with my wife and business partner Carole Ellis(she’s a real business partner… not just because she’s my wife… I’d want to work with her if I wasn’t married to her… and I’d want to marry her, too). I also have 4 children ranging in age from 2 to 20 (yes, you read that correctly).
It’s my goal to be the name everybody thinks of when they think of Self-Directed IRA’s and Solo 401(k)’s.