For every rule, there seems to be an exception. In the case of employers who procrastinate on establishing tax-qualified plans, the window of opportunity starts to disappear as the calendar year winds down -- but there is an "exSEPtion" to that rule.
Unlike other employer-sponsored plans that require a plan document to have been signed by Dec. 31 to keep the funding option open until the tax due date, the Simplified Employee Pension (SEP-IRA) provides an exception that might be worth considering.
SEP-IRAs are qualified plans under IRS Code 408A. The code allows SEP-IRAs to be established (plan document signed) and funded by the employer's tax due date, including tax extensions. This "exSEPtion" to the rule allows the business owner figuratively to extend the calendar year beyond Dec. 31 to April 15 or later if extensions are granted.
Any tax entity -- corporation, sole proprietor, or partnership -- can establish an SEP-IRA. Although there are differences in the amount of potential tax deductions based on the definition of reporting of income, the advantages of an SEP-IRA to business owners can be significant. On page 28 of the July 2006 issue of LIFE INSURANCE SELLING are two examples of how this plan would work depending on the employer's tax entity (see "SEP Deduction by Ownership Type").
An employer should use two tools to help establish an SEP-IRA plan:
1. The IRS 5305-SEP form, which is available on the Internal Revenue Service Web site, http://www.irs.gov/. Be sure to check eligibility to use this prototype and eligibility requirements for employees. Even though SEPs are not subject to ERISA reporting and disclosure requirements (i.e., 5500 forms), plan compliance still is an issue and is the plan sponsor's responsibility.
2. An annuity or mutual funds application. Unfortunately, the IRS does not permit the use of life insurance within SEP-IRAs.
The "exSEPtion" concept of saving tax dollars next year for the year 2006 is a great door opener. Prospects could include:
o Yourself as an agent and business owner.
o Your business clients.
o Your accountant. He or she might have clients who want or need deductions for 2006.
After introducing the SEP-IRA concept, the next step is to show prospects the other options that are available for 2006. These alternatives could be more attractive depending on a company's objectives, cash flow, deduction, and flexibility needs. Compare these options, based on recently released 2006 IRS COLA limits, which also are available on the IRS Web site.
Another exception applies in the first year of the SEP-IRA. If the contribution for the SEP is made in 2007 for the 2006 tax year, the individual is not deemed to be an active participant and might be eligible for an individual IRA deduction. So much for SEP-IRAs being simple.
Four other SEP compliance issues that should be considered are:
1. Existing SEP-IRAs, whether using the IRS form 5305-SEP or a non-model SEP document, need to be amended to comply with provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001. These amendments do not have to be filed with the IRS.
2. In some circumstances, employers might not be eligible to adopt the IRS 5305-SEP form and must use a non-model document. Be aware of these to ensure that the SEP plan is compliant.
3. An employer adopting an SEP must make sure that all sections of the 5305-SEP form are completed and accurate -- especially if employees are involved -- to ensure that they are included and allocated the correct contribution amount.
4. Although SEP-IRAs currently are not subject to ERISA 5500 reporting and disclosure filings, there are other administrative requirements to ensure copmliance and maintain deductions.
Back Room Technician, a software package from Kettley Publishing, has an excellent reference chart that compares SEP-IRAs to profit-sharing plans. Additional material on SEPs can be found in IRS Publications 560 and 590, which are available on the IRS Web site.
The SEP-IRA could benefit your clients and lead to other sales opportunities. Actual demographics will affect options and choices of plans selected by employers. As your clients' trusted adviser, you should perform a feasibility study to determine which plan(s) would work best for each situation.
For those clients who need the maximum amount of time allowable for their decisions, however, it pays to remember that with the "exSEPtion," the year isn't over until the tax forms are filed.
Keith Baumgarn is sales vice president of qualified markets at Lafayette Life and has more than 25 years of experience in the qualified plan market. His department administers more than 800 pension plans. Mr. Baumgarn is a member of the American Society of Pension Actuaries, serves on the board of directors for his local Society of Financial Service Professionals chapter, and is a past moderator for LUTC business courses.
