By Sarah Brenner, JD
Director of Retirement Education
A Simplified Employee Pension (SEP) is a popular choice for many small employers. Although these plans are in fact designed to be less complex than other types of retirement plans, there are many ways to go wrong and make errors. Here are three tips to avoid tax problems with your SEP.
1. Execute the SEP Documents.
Who cares about paperwork? If you are an entrepreneur establishing SEP IRA plan for your rapidly growing business, that may be the last thing on your mind. But guess who does? Yes, the IRS. There are two separate documents needed to run a SEP IRA plan. If both are not executed properly, then both you and your employees could be looking at some serious tax problems.
The first document is the plan document that the employer must fill out. The employer must complete a SEP agreement, which describes the SEP plan features and eligibility rules. The employer then has to give a copy of this completed document to the employees. Often, employers use the IRS model SEP agreement – IRS Form 5305-SEP. Some employers use prototype SEP agreements which are written and sent to the IRS for approval, usually by a financial organization. You do not need to send the agreement to the IRS, but you will want to keep it with your records and use it as a reference since it sets out the plan terms.
The second part of a SEP agreement is the IRA that receives the employer SEP contributions. Every employee who is eligible to participate in the SEP, including the business owner, must establish an IRA to receive the SEP contributions.
2. Update the SEP Plan.
Many employers will get it right at first. They will complete a SEP agreement and their employees will establish IRAs. However, the job does not end there. A common error with SEPs involves the agreements not being amended at all or not in a timely fashion. To find this mistake, if you are using the IRS Form 5305-SEP as your plan document, check the latest revision date in the top left-hand corner. The most recent version is dated December 2004. Anything earlier than December 2004 could indicate a problem. If you chose to use a prototype document to establish your SEP IRA plan, contact the financial institution offering the plan for a letter stating that the IRS approved the plan for current law.
3. Fix Mistakes.
What if your SEP IRA plan agreement has not been updated? This is a problem that can be fixed. The IRS has many resources and programs available to help. It is much easier and less expensive to correct the error before the IRS finds it in an audit. If you have questions about your SEP IRA plan and possible document mistakes, the best place to start is a consultation with tax or financial advisor who is knowledgeable about the SEP IRA plan rules.