SEP Plans Simpler Than Keoghs

QUESTION: I started a little side business last year and planned all year long to put the little bit of money I made from it into a Keogh retirement plan. I procrastinated so long that I never got around to opening an account. And now, some of my friends are saying it’s a good thing--that I’d be much better off with something called an SEP retirement account instead of the Keogh. Can you tell me what it is and if it is a better choice?--B. R.

ANSWER: SEP, short for Simplified Employee Pension Plan, is a special kind of individual retirement account that combines many of the best features of IRAs and Keoghs.

Like an IRA, the administrative headaches are few with an SEP--an important distinction from the Keogh, which has become so burdened with bookkeeping requirements that many former Keogh owners have closed their accounts. Also, like an IRA, an SEP can be opened as late as April 15 following the year in question and still qualify for the prior year’s tax break. Contributions to Keoghs can be made that late, but the accounts must be opened by the prior Dec. 31.

What the SEP does retain of the Keogh is its best feature: much higher savings limits than the IRA--up to $30,000 a year instead of the maximum $2,000.

SEP participants also can keep contributing as long as they work, even past the IRA cutoff age of 70 1/2.

(The only time an IRA participant can continue to contribute to an IRA beyond age 70 1/2 is if he or she has a spousal IRA and the spouse is younger than 70 1/2. A recent Money Talk column was wrong in saying that, under some circumstances, IRA participants who continue to work beyond age 70 1/2 can continue to make IRA contributions. Only participants of so-called qualified plans--such offerings as Keoghs, profit-sharing plans and pension plans--have that option.)

But, as some pension attorneys point out, that is a mixed blessing because of the confusion created when a taxpayer is still contributing money to a fund from which he has to withdraw money at the same time. SEP participants do have to begin withdrawing money from their accounts no later than the April 1 after they turn age 70 1/2, even if they are still working and choose to keep contributing money to the account.

The biggest drawback to the SEP is that, unlike a Keogh, it does not permit 10-year income averaging for taxpayers who want to withdraw the full amount from their SEP account upon retirement and pay the taxes on the spot.

If you are the only employee of your little business, as you seem to be, starting an SEP is as easy as opening an IRA account. All you have to do is sign a one-page form. If you have employees, though, you must include them in this retirement plan. In that case, you simply deliver a copy of this form to each employee and establish separate IRA accounts on their behalf. Your contributions into these employee accounts are tax deductions for you, and any contributions that the employees make into those same accounts--up to $2,000 a year is permitted, assuming that they don’t contribute to any other IRA plan during the year--is a tax deduction for them.

Other than that, all you have to do is report to these employees once a year. No annual reports to the government are required, a big advantage over the Keogh administrative requirements.

The reason that some employers shy away from SEPs is that employee participants are vested immediately, meaning that they are entitled to all of the money in their account even if they leave the company shortly after the plan is started for them.

As the owner of a one-employee business, you may contribute up to $30,000 a year, or 13.04% of your self-employed income, whichever is less. You also are entitled to put aside another $2,000 a year in an IRA.

Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Business section, The Times, Times Mirror Square, Los Angeles 90053.