Every time Congress tampers with Qualified Pension and Profit Sharing Plans, it seems to backfire. Instead of affording greater protection to plan participants as intended, wholesale terminations of plans by beleaguered small businesses invariably ensue. That is hardly the way to protect plan participants.
Defined Benefit Plans have been especially vulnerable to terminations, as they become increasingly burdensome to administer and more costly to maintain.
Nor have the so-called “top heavy rules” helped matters. The government’s Pension Benefit Guaranty Corporation is being strained to the limit handling such terminations. The termination of the Kaiser Steel Pension Plans alone caused a $227,000,000 charge to the fund.
The revenue Act of 1978 created a new type of qualified retirement plan under Section 408(k) of the Internal Revenue Code. Better known as the Simplified Employee Pension Plan (SEP), it never really caught on because the maximum contribution was 15% of compensation up to a limit of only $7,500. This did not excite business owners, who could put far more into a Pension or Profit Sharing Plan. In 1982, TEFRA expanded the maximum to $15,000. The response nevertheless continued to be underwhelming.
In 1985, however, the rules changed dramatically. Now there is parity between all Qualified Pension and Profit Sharing Plans, including Keogh and the Simplified Employee Pension. As a result, a contribution of up to 15% of compensation or $30,000 (whichever is less) was permitted. EGTRRA 2001 and JCWAA 2002 further enhanced the SEP. Contributions for 2002 are allowed up to the lesser of $40,000 or 100% of compensation. The Simplified Employee Pension, the ugly duckling of qualified plans, has become a beautiful swan!
The SEP is built around the IRA concept, but without the $2,000 limitation. Just as with an IRA, all SEP contributions are immediately and fully vested. Should an employee work for more than one employer, he or she may be covered by a SEP of one employer and a Pension or Profit Sharing Plan of another employer.
A SEP Plan must cover all employees age 21 and older, who have “performed services” for the employer during the calendar year, and for at least three of the immediately preceding five calendar years. Employees covered by a collectively bargained pension may be excluded.
As with other qualified plans, employer contributions to a SEP may not discriminate in favor of officers, shareholders, self-employed individuals or highly compensated employees. A flat percentage of compensation satisfies this requirement.
If there is no other qualified plan in effect, integration with Social Security is permitted in a SEP, to the extent that the employer contributions for each employee may be reduced by the amount of the employer’s share of Social Security Tax.
The employer’s contribution to a Simplified Employee Pension is, of course, deductible, provided it does not exceed 25% of covered compensation (to a maximum of $40,000) per employee per calendar year. Contributions may be made up to April 15 and still be treated for tax purposes as though they were made during the prior calendar year.
Installation of a SEP Plan could not be simpler. IRS Form 5305-SEP serves as both the agreement and disclosure form. Unlike most IRS forms, it is the ultimate in simplicity. But more than that, it is not even filed with the IRS!
In one important aspect, the SEP is similar to a Profit Sharing Plan in that the employer is not obligated to make contributions. It is a year-to-year decision as to what, if anything, the employer may elect to contribute.
A Money Purchase Pension Plan, on the other hand, entails a promise to make a defined contribution each year, regardless of profits. A Defined Benefit Plan also entails a promise, to fund a known benefit upon retirement. An employer who fails to meet the “minimum funding standards” of these plans may be subject to a penalty tax (but not to a disqualification of the plan).
By way of contrast, a Profit Sharing Plan or a SEP contains no promise at all, giving the employer the kind of flexibility and control that accountants like to see. A Profit Sharing Plan has strict reporting requirements, however, whereas an SEP has none.
No reporting. No administration. No trust. No actuarial requirements. No fiduciary responsibility. That is the beauty of the 408(k) Simplified Employee Pension Plan!
Source: Tax Facts 2007, National Underwriter Company
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