Case of the Week: Forms of SEP Plan Documents and When to Use Them

The ERISA consultants at the Retirement Learning Center Resource regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans.

A recent call with a financial advisor from New York is representative of a common inquiry related simplified employee pension (SEP) plans. The advisor asked:

“I have a client that would like to establish a SEP plan. What document options are available and what are the considerations for selection?”

Highlights of Discussion

Employers that sponsor SEP plans must maintain them pursuant to a written document [Internal Revenue Code Section (IRC §) 408(k)(5). There are three document format options for SEP plans:

There are several considerations when selecting a SEP plan document, including (but not limited to) cost, whether the sponsor maintains other retirement plans, and desired design features.

Regardless of the format used, the deadline for establishing a SEP plan for a particular year is the business’s tax return deadline, plus extensions for that year.

EXAMPLE

Pete’s Partnership operates on a calendar year, and has a five-month filing extension for its 2017 tax return. If the partnership wants a 2017 SEP plan, it has until Sept. 15, 2018, to sign a document to set up the plan.

Form 5305-SEP

The IRS model Form 5305-SEP is available free of charge on the IRS website, and there is no need to file a completed copy of it with the IRS. The IRS will consider a SEP plan as established using the model form when the sponsor completes and signs the form without modification; each eligible employee (or, as a last resort the SEP plan sponsor on behalf of an employee) establishes a traditional IRA to receive contributions, and the employer gives required notices to all eligible employees.

A SEP plan sponsor may not use the model Form 5303-SEP if any of the following statements are true. The employer —

  • maintains any other qualified retirement plan (except for another SEP or salary reduction SEP plan);
  • has any eligible employees for whom traditional IRAs do not exist;
  • uses the services of leased employees;
  • wants a plan year other than the calendar-year;
  • wants to exclude members of a controlled group of employers; or
  • wants a contribution allocation formula that is other than pro rate (i.e., integrated with Social Security or flat dollar).

Prototype SEP

Prototype SEP plan documents are available for a nominal fee from various prototype document sponsors for use when a model form is not permitted and/or the employer wants more flexibility in plan design. By filing IRS Form 5306-A, Application for Approval of Prototype Simplified Employee Pension (SEP) or Savings Incentive Match Plan for Employees of Small Employers (SIMPLE IRA Plan) and paying a fee, a prototype document sponsor (e.g., a bank, credit union, mutual fund company, etc.) can receive pre-approval of its plan document from the IRS in the form of an IRS opinion letter. An opinion letter states that a SEP agreement is acceptable in form. The IRS has prepared a Listing of Required Modifications (LRMs), or sample language, to assist document sponsors in drafting an acceptable prototype SEP.

An employer using a prototype SEP plan document, rather than a model, can:

  • use the business’s fiscal year as the plan year rather than the calendar year;
  • use the services of leased employees;
  • select a pro rata, integrated or flat dollar contribution allocation formula;
  • maintain another qualified plan in addition to the SEP plan; and
  • contribute a top-heavy minimum contribution only when the plan is actually top-heavy.

Individually Designed Documents

An employer can engage an attorney to draft an individually designed SEP plan document that is unique to the employer, and request a letter ruling from the IRS as to its acceptability, if desired. While these employer-specific documents can be more flexible than a model or prototype document, an adopting employer will incur higher costs as a result of drafting, establishment and maintenance fees.

Conclusion

The IRS requires businesses that want SEP plans to execute a written plan document containing the terms of the arrangement. There are three general SEP plan document formats from which to choose. Considerations as to the most appropriate form include, but are not limited to, cost, whether the business maintains other retirement plans and desired design features. Business owners should consult a tax and/or legal advisor regarding their particular circumstances.

Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.

©2018, Retirement Learning Center, LLC. Used with permission.

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