A Simplified Employee Pension (SEP) is an employer sponsored retirement plan where contributions are made to employees’ IRAs. Don’t be fooled by the name! Although these plans are in fact designed to be “simplified” or less complex than other types of retirement plans, there are ways to go wrong and make errors. A seemingly small mistake with a SEP IRA plan can cause big problems.
Who cares about paperwork? If you are an entrepreneur establishing a 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 fill out 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, which is 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.
Update for Current Law
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 in a timely fashion or even not at all. 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.
To avoid this mistake, do a yearly check of your SEP IRA plan agreement. You should either look for the model form on the IRS website, or contact the financial institution about the prototype plan to ensure the current plan is in use. Also, be sure that the new SEP agreement is signed and dated. Don’t make the mistake of thinking you can just add it to your plan paperwork. An unsigned or undated agreement may mean that the plan is not amended for current law in the eyes of the IRS.
Fixing the Mistake
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.
By Sarah Brenner, IRA Analyst