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SEP-IRAs – A Retirement Plan Option for Small Businesses

A Simplified Employee Pension plan may be the right solution for these owners. Also known as a SEP-IRA, this is a low-cost, easy-to-administer retirement plan that’s often ideal for owners of small businesses and self-employed individuals. Sole proprietorships, S and C corporations, partnerships and LLCs all may qualify to establish a SEP-IRA.

The Nuts and Bolts

With a SEP-IRA, each employee (including the owner) opens his or her own Individual Retirement Account, and the business makes tax-deductible contributions into these accounts. Employees cannot contribute to their SEP-IRA accounts—employers make all contributions. Like contributions to traditional IRAs, contributions to SEP-IRAs grow on a tax-deferred basis, and employees enjoy immediate vesting of all money contributed to their accounts.

One of the benefits of SEP-IRAs is their generous contribution limit: up to 25 percent of the employees’ (or the owner’s) compensation or $50,000 in 2012, whichever is less. Keep in mind, however, that the same percentage of compensation must be contributed to each eligible employee’s account, including the owner. However, this percentage can be changed each year based on the business’ profitability and how much it can afford to contribute.

To be eligible to participate in a SEP-IRA, an employee must be 21 years of age or older, have worked for the company at least three of the past five years, and have received at least $550 in compensation for the year in 2012*. Employers must make contributions in the same proportion for all employees who meet these criteria, including part-time and seasonal employees.

An Employee Motivation Tool

SEP-IRAs can be especially attractive to businesses that want to motivate employees to help the business meet certain financial goals. For example, the owner could tell employees at the beginning of the year that if sales or profits exceed a certain level for the year, the SEP-IRA contribution for each employee with be x percentage of salary.

This way, the business can protect itself from committing to a contribution percentage that it might not be able to afford, and it’s able to change this percentage from year to year based on the company’s financial performance.

SEP-IRAs generally must be established and funded by your tax-filing deadline (or April 15 for most companies). This means you have until April 17, 2012, to set up and fund a SEP-IRA for tax year 2011.When setting up your SEP-IRA, you will complete IRS Form 5305, which establishes the requirements for determining who is eligible to participate in the plan.

While you can make the eligibility requirements for participation in a SEP-IRA less strict than those listed above, you can’t make them stricter. Any employee who meets the eligibility requirements stipulated on Form 5305 must receive SEP-IRA contributions in proportion to his or her salary.

*IRS Publication 560

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