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Simplified Employee Pension Plan (SEP)

Set up by qualifying small business employers, A Simplified Employee Pension Plan (SEP) allows more monetary contributions to be made to a special type of Individual Retirement Account (IRA) than is allowed under regular IRA rules.

Self employed individuals may set up a SEP as an alternative to a Keogh Plan and the SEP must cover all employees who are at least 21 years old and who has worked for the employer during at least 3 of the past 5 years.

It allows an employer to deduct and contribute to an employee's IRA account portions of wages up to 25% that are excluded from pay and are not included on Form W-2, unless the contributions exceed the the 25% limit.

Under the SEP, contributions do not have to be made every year and when contributions are made, they must be made based on a written allocation formula and must not discriminate in favor of owners with more than a 5% interest or any highly compensated employees.

If contributions to the SEP exceed more than the 25% allowed, the excess is included in the employee's gross income and a penalty of 6% is may be imposed unless the excess is withdrawn before the date of the return.

If an employee makes any withdrawals from the SEP before age 59 1/2, the withdrawal is subject to a 10% tax penalty. The exceptions to this rule include:

  1. The employee is totally disabled
  2. The employee pays medical expenses exceeding 7.5% of adjusted gross income.
  3. The distribution was due to an IRS levy.
  4. If you are a beneficiary following the death of an owner.
  5. A distribution of $10,000,00 or less is used to pay first time home buyers expenses.
  6. If the owner of the SEP receives unemployment benefits for at least 12 consecutive weeks and pay medical premiums.
  7. The distribution is used for higher quality education.
  8. If the employee makes a qualifying rollover to another plan.

The deadline for setting up and contributing to a SEP is the due date of your return, including extensions.

If you have not set up a Keogh plan by the end of the taxable year, you may still make a deductible retirement contribution for the year contributing to a SEP, as long as it is made by the due date of your return.

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