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Establishing a SEP

Sole proprietorships, partnerships, corporations, and tax-exempt organizations are all eligible to establish SEPs. The plan must be in writing and deductible contributions made by tax-filing time plus extensions. There are three options for setting up the plan:

  • execute the IRS Model Agreement, Form 5305-SEP,
  • execute a master or prototype plan which has received a favorable opinion letter from the IRS, or
  • execute a custom-designed plan.

Either the IRS model SEP agreement or a prototype plan can be used by businesses that seek a simplified way to establish the SEP.

Ineligible Employers

Some employers are not eligible to use the IRS model SEP agreement, but may be eligible to use a prototype. These are employers who:

  • maintain another qualified plan;
  • have ever maintained a defined benefit plan;
  • use the services of leased employees;
  • have an eligible employee who has not established an IRA;
  • are part of an affiliated service group, controlled group of corporations or are under common control unless all eligible employees of all such employers participate in the SEP;
  • wish to integrate SEP contributions with Social Security; or
  • do not pay the cost of SEP contributions.

Who Can Participate in a SEP?

Every employee who is age 21 or over during the year for which contributions are made and who has performed services for the employer in three of the five years preceding the year for which contributions are made must participate in the SEP. Service is defined as any interval of time in which the employee has performed any work for the employer in a particular year.

Once an employee becomes eligible to participate, he or she will share in contributions only if compensation for the year is more than a specified annual threshold ($500 for 2008). If an employee meets these requirements, a contribution must be made on the employee's behalf for that year even if the employee is no longer employed at the time the contribution is made. There are no exceptions, even for employees who are older than age 70½.