Advantages of SEPs and how they work

In addition to Keogh plans, there’s another, even simpler pension plan for sole proprietors and small corporations called the Simplified Employee Pension or SEP.

A SEP account is a cross between a 401(k) account and an IRA. With a SEP account, you open an IRA account and then your employer deposits money into the account on your behalf. After the money’s deposited, it’s your money, and you can treat it as you would any IRA money.

The employer gets to deduct the contribution as a wage expense, and the contribution never shows up on your W-2 as taxable income so you both win.

If you’re self-employed, you take your SEP contribution as an adjustment to your income on the front page of your 1040, like you would do if you had an IRA or a Keogh plan.

One advantage that a SEP offers relative to a Keogh plan is its simplicity of administration. There are fewer forms because the employer is no longer responsible for management of the money after it’s been deposited in the employee’s account.

Disadvantages of SEPs

There are, however, some drawbacks to using a SEP relative to the more cumbersome Keogh account. First, you can’t save as much using a SEP. With a SEP, a self-employed person can put away up to 13 percent of their net income for themselves.

Employers can also contribute up to 15 percent of the salary of each employee. The employer must contribute the same percentage to all employees who have worked for him for three years or more, and all contributions are immediately vested with the employee. This is stricter than the 401(k) account which allows vesting over five to seven years.

A SEP is quite flexible, however. If things are good one year, you can contribute 10 percent or more to all eligible employees. If you’ve had a bad year, you can skip contributions entirely.

SIMPLE Plans

Just as we were going to the studio to record this tape, Congress passed a law which allows a new form of retirement accounts for small businesses called the Savings Incentive Matching Plan for Employees, otherwise known as SIMPLE.

Believe me folks, I didn’t come up with this name. The politicians in Washington did.

Anyway, a SIMPLE plan allows workers to save up to $6,000 of their own money into an IRA. Employers must provide a flat match of 2 or 3 percent of each worker’s salary.

Because these are new plans, we don’t have much information on them, but if you’re in a small business, you should ask your mutual fund or bank for information on SIMPLE plans.

Self-employeds should set up Keoghs or SEPs

If you’re self-employed you should seriously consider setting up a SEP or Keogh plan for yourself. Most of the Keogh plans are easy to set up, and SEPs are even easier. Both Keoghs and SEPs allow you to save much more money than an IRA.

SEPs and Keoghs can be set up easily through most mutual funds or banks. These institutions have plan documents that usually already have received approval from the IRS. To set up your own retirement plan just fill out the paperwork and send in a check.

If you work for a small business that currently doesn’t offer a retirement plan, you should ask your employer about setting up a SEP or a Keogh plan. You can do this in a win-win manner.

Instead of haggling with your boss over a 5 percent raise, cut a deal with him. Tell him you’ll take a 3 percent raise if he sets up a retirement plan. Because of the tax savings possible through retirement plans, both you and your boss could come out ahead on an after-tax basis.

Copyright 1997 by David Luhman

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