Non-Contributory SEP

[Guest R. Daestrom]

I'm not real familiar with SEP's, but I was asked recently about a small business starting a non-contributory SEP. I honestly have never heard of this distincton ("non-contributory") used with a SEP before, but I suspect it just means a SEP in which the eligible employees can contribute pre-tax money, but to which there is no employer contributions made. Thats what the owner thinks (and wants) here.

Does this sound OK, and if the owner does not contribute to the plan, is there really any benefit to sponsoring this plan?

[Bird]

Prior to 1997, a small business could sponsor a SARSEP (SAlary Reduction SEP) which would allow employees to contribute pre-tax money. You can't start a new one now, although if you had one prior to 1997 you can continue it.

SIMPLE IRAs more or less replaced them, but of course they have a required employer contribution of some sort.

[Guest R. Daestrom]

Bird - Sign me up for the next SEP 101 course, but I thought ee's could contribute up to $3,000 in a SEP (pre-tax) and that SEP employer contributions could vary year-to-year. I assumed this meant it could vary as low as $0 in a given year?

[Bird]

I have no clue whatsoever about the $3,000. I've been wrong before but I don't think there is or ever was such a thing.

Yes, SEPs can do 0-15%. Note that I was talking about SIMPLEs when I said there was a required contribution.

[Lori Friedman]

Bird, it's actually 0% - 25% of compensation under Sec. 414(s). The 15% was for years beginning before 01/01/02.

[No Name]

Perhaps the $3,000 figure is a regular IRA limit? No "employer plan" there.

[Demosthenes]

There really isn't any such animal as a non-contributory SEP.

Basically, if the employer makes a contribution to the SEP then the contribution must be allocated using the same % of compensation to all eligible participants. Form 5305-SEP is the model form and available at the IRS web site.

It's a short sweet description of the requirements and I'm betting that whoever told your client about SEPs has never read it.

This is a very common mistake, I can't tell you the number of times I've seen someone establish a SEP and only make contributions to their account. Often it's on the advice of someone else who has a SEP and only makes contributions to themselves. Or the advice is traced back to a broker or accountant unfamiliar with the regs.

In any case, it doesn't fly with the IRS and bad things happen. The worst case I've seen; go back to the date the SEP was established, credit the % of compensation placed in the owners account (in this case the max allowed in each year) to all eligibles and make up the foregone earnings.

[Belgarath]

Even a lot of the old SAR/SEP's didn't end up being "noncontributory." If they used the 5305A-SEP model, and any key employee deferred, the plan was deemed top heavy and minimum contributions were required for the nonkeys. I saw a fair number of people get shocked on this one.

[Bird]

Bird, it's actually 0% - 25% of compensation

yep. That was a typo...I hope. I'm pretty sure I've got that 15% stuff out of my head by now!

[Earl]

Kind of beat to death here, but one more point...

only plan that I know of that could run with only employee contributions (no employer funding) is a 401(k) Plan.

Just watch out for Top Heavy (as opposed to ADP discrimination issues).

[Appleby]

Agreeing with earlier comments-Regular Traditional IRA contributions up to $3,000/$3,500 may be contributed to a SEP IRA. But if the only contribution to the account is the regular IRA contribution, then it is not a SEP as it is the employer contribution that makes a Traditional IRA a SEP IRA.