SEP & SIMPLE IRA Retirement Plans — Know & Avoid These Common Errors

June 23, 2016 – The IRS recently identified a number of common errors seen in two of the most popular retirement plans used by small businesses — the SEP plan and the SIMPLE IRA plan.

General Rules for SEPs

With a SEP (Simplified Employee Pension) plan, employers establish individual retirement accounts (IRAs) for each eligible employee. Contributions are made only by the employer (except in the case of SARSEP plans in place on December 31, 1996). The employer has discretion as to whether to make annual contributions.

Contributions are tax deductible by the employer, subject to inflation-adjusted limits. For 2016, the maximum contribution for each employee is the lesser of 25% of annual compensation (up to $265,000) or $53,000. Employees are not taxed on employer contributions until they are withdrawn from the plan.

Common SEP Errors

Errors commonly seen by the IRS include:

Discrimination in employer contributions. Plans may not discriminate in favor of “highly compensated employees,” generally defined as 5% owners or persons with compensation exceeding $120,000 (for 2016). Contributions must bear a uniform relationship to the first $265,000 (for 2016) in compensation.

Improper exclusion of employees. Eligible employees include all those who have (1) reached age 21, (2) performed services for the employer during at least three of the immediately preceding five years, and (3) received at least $600 in compensation.

Failure to take required minimum distributions (RMDs). All SEP participants must begin taking RMDs at age 70½, whether or not they are still working.

General Rules for SIMPLE IRAs

Unlike a SEP, a SIMPLE (Savings Incentive Match Plan for Employees) IRA requires annual employer contributions and allows employee salary deferrals. Generally, the employer must either (1) match employee salary contributions up to 3% of pay or (2) contribute 2% of pay for each eligible employee. For 2016, employee elective deferrals may not exceed $12,500 ($15,500 for employees age 50 and older).

Common SIMPLE IRA Errors

Frequently seen errors include:

Insufficient matches. The employer match may fall below 3% in no more than two out of the previous five years.

Failure to provide required 60-day notices. Generally, during the 60-day period prior to the beginning of the plan year, all eligible employees must receive notice of (1) the employer’s decision to make a fixed or matching contribution, and (2) the employee’s right to make or modify a salary deferral election.

Errors Common to Both Types of Plans

These include the following:

Improper application of “compensation.” The definition of “compensation” used in administering the plan must comply with both statutory and plan requirements. For example, a common failure is the omission of bonus payments for purposes of determining the employer’s plan contribution.

Failure to update plans. For both SEP and SIMPLE IRA plans, the IRS is finding that employers often fail to make amendments necessary to keep their plans current with changing laws and regulations. The IRS recommends that plan reviews be made annually.

Think Your Plan Needs Some Correcting?

Many errors in administering a retirement plan may be fixed through the IRS’s correction programs. Please contact your Dopkins Tax Advisory for help.

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