SEP IRA

Renata owns a small landscaping business with three eligible employees and establishes a SEP IRA for the firm. Under a SEP, contributions:

1. A.Come from the employer only, and must be the same percentage of compensation for every eligible employee, including Renata herself.Correct. Employer funding and a uniform contribution percentage are the two defining features of a SEP.
2. B.Come from employees only, through salary deferrals they elect each pay period.That describes a salary deferral plan such as a 401(k) or SIMPLE. A SEP is funded by the employer.
3. C.Are chosen individually by each employee at whatever percentage he or she prefers.Employees have no election in a SEP. The employer sets one percentage that applies to everyone.
4. D.Are made with after-tax dollars and grow entirely tax-free like a Roth account.Traditional SEP contributions are pre-tax to the employer and grow tax-deferred, with distributions taxed as ordinary income.

Why: A SEP is an employer-funded plan built on top of IRAs. The employer decides each year whether to contribute and how much, but whatever percentage of compensation it chooses must be applied uniformly to every eligible employee, including the owner. Employees do not make salary deferrals into a SEP. Review employer-sponsored retirement plans in the retirement accounts topic.

Marisol Vega owns a small veterinary practice and funds a SEP IRA for the business. Her plan document uses the most restrictive eligibility conditions a SEP is allowed to impose. Assume those conditions are: the employee must be at least 21 years old, must have performed service for the employer in at least 3 of the 5 immediately preceding years, and must have received at least 750 dollars of compensation for the current year. Which staff member MUST be covered this year?

1. A.A 34-year-old part-time receptionist who has performed service in 3 of the last 5 years and earned 900 dollars this year.Correct. She clears the age test, the three-of-five service test, and the 750-dollar compensation floor, so she must be covered.
2. B.A 19-year-old kennel technician who has worked in 4 of the last 5 years and earned 22,000 dollars.She fails the age screen. A SEP may exclude employees under 21 regardless of service or pay.
3. C.A 45-year-old veterinary assistant hired 14 months ago who earns 48,000 dollars.She has service in only 2 of the preceding 5 years and may be excluded, however large her salary.
4. D.A 52-year-old bookkeeper with service in all 5 preceding years who earned 600 dollars this year.She fails the compensation floor, so the plan may exclude her for this year.

Why: A SEP may exclude employees who fail any one of the three permitted screens: age, the three-of-five-years service test, or the minimum compensation floor. An employee who clears all three must be covered, and part-time status by itself is not a permitted exclusion. The receptionist is 21 or older, has service in 3 of the preceding 5 years, and earned more than the 750-dollar floor, so she is in the plan even though her pay is small.

Which statement about a SEP IRA is correct?

1. A.Employer contributions vest over a six-year graded scheduleGraded vesting belongs to some qualified plans; SEP contributions vest immediately and completely.
2. B.Employees fund it through pre-tax salary deferralsSalary deferral is a 401(k) and SIMPLE feature - SEPs take employer contributions only.
3. C.It is available only to employers with 100 or fewer employeesThe 100-employee ceiling is the SIMPLE plan's limit - SEPs have no such cap.
4. D.Only the employer contributes, contributions are discretionary each year, and employees are immediately 100 percent vestedCorrect - employer-funded, flexible year to year, and instantly vested.

Why: A SEP is funded solely by EMPLOYER contributions, which are discretionary from year to year, and participants are always immediately 100 percent vested. Employees do not defer salary into a SEP. The clue is separating SEP mechanics from 401(k) and SIMPLE features. Review: employer-sponsored IRAs.