Remember ERISA, that funny little bill that became law in 1974? Remember all the problems we had with the concept of IRAS created by that law; and how so many of those problems were resolved so effectively by amendments under the Revenue Act of 1978? While we were basking in the radiance of these changes, an evil little cloud almost slipped past us. The statute calls this little cloud a "simplified employee pension plan". Based upon the number of calls which we have received about this "wonderful" new concept, one might think that a STAR had appeared over $152 of the Revenue Act of 1978 (RA 78), where this provision is found. Through this article, we hope to show that its name is an anachronism. We will, therefore, use the term "SEPP" (one which your author does not like) to identify this odd creature of the Congressional imagination. Our leaders recognized a problem, tried to deal with it without a full appreciation of the ramifications of their approach, and fell on their proverbial seats. We anticipated these short comings when the concept was first introduced in the Bentsen bill (S-3140). [see our Issue #78-14/15/16, P.12) / Each time your author reads the aforementioned $152, he discovers many new questions and very few answers. We are afraid that this, as with the "mini-Keogh" and the "Spousal IRA", is just another IN THIS ISSUE: Season's case where Congress took a good The basic problem, as we see it, is that the SEPP is neither fish nor foul it is not an IRA, nor is it a qualified plan....but something in between. Congress's approach was to take the existing Copyright 1978 by IPCO, Inc. PUBLISHED BY: IPCO INŠTITUTIONAL PENSION CONSULTANTS, INC. NEW YORK OFFICE 475 PARK AVENUE SOUTH, NEW YORK, NY 10015 (212) 689 0652 IRA structure and use it as the foundation upon which to build. Remember the Employer IRA? That s the concept contained in $408(c) of the Code of which so few Employers have taken advantage. A SEPP is similar to an Employer IRA in that the Employer contributes to the employee s Simplified Plan. Rules of the SEPP Are As Follows: 11 (1) Participation: All employees who have attained the age of 25 and who have performed service with the Employer during at least 3 of the immediately preceding 5 calendar years must be eligible to participate in a SEPP; and if the Employer makes any SEPP contributions for the year, must have contributions made by the Employer into their SEPP. In certain cases, the "Plan may exclude union employees as well as non-resident aliens. However, the Congressional intent appears to have been that the SEPP into which the Employer will make those contributions will be established by each employee. If the employee refuses to establish the SEPP, it is very unclear as to what, if anything, will occur. [This may not necessarily mean that an employee is prohibited from establishing a SEPP and making his own contributions into it prior to his reaching age 25 or completing 3 years of service with the Employer. In any event, however, the Employer is not required to contribute into the Plan until those requirements are met.] (2) Contributions: Contributions must be of a uniform percentage of compensation for all plan participants (Only the first $100,000 of any participant s annual compensation may be used as the basis for a contribution). However, Employer contributions into a SEPP are considered wages paid to the employee. This means that the Employer takes a deduction for the amount he contributes into the SEPP on behalf of the employee. The employee has this amount included in income and is then entitled to a deduction to the extent that the amounts contributed into the SEPP on his behalf by all his Employers during the year do not exceed 15% of his earned income, not to exceed $7,500. An important negative feature of the SEPP is that the Employer and the employee must both pay FICA (Social Security) and other payroll taxes on the Employer contributions, to the extent that the contributions, when added to the employee s other compensation from that Employer, do not exceed the Social Security Wage Base (which is $22,900 for 1979). For Example: The Pitty Pat Plastics Corp. contributes 15% of compensation for 20 of its employees, each of whom earns $12,000 annually. The contribution on behalf of each of the employees is, therefore, $1,800. The full $36,000 (20 employees X $1,300 per employee) is subject to FICA. The FICA rate for 1979 is 6.13%. (1) Employer Cost of 1979 SEPP contribution (2) Aggregate Employee Cost of 1979 SEPP contribution $36,000 X 6.13% = $2,206.80 36,000 X 6.13% = $2,206.80 (3) Vesting And Withdrawals: The Plan must provide full and immediate vesting of all Employer contributions. Also, the Employer cannot impose any restrictions on the withdrawal of funds from the SEPP by the employee. This will add some interesting considerations. any Employers who have establised Employer IRAs with no restrictions on withdrawals have found that typically many of these employees immediately withdraw the Employer s contribution. This adds greatly to the administrative burdens of the trustee or custodian institution. Since these funds are not of a long term nature, it detracts from the attractiveness of the Plan. The only impediment is the 10% premature distribution penalty, if the participant is under age 59 1/2; and the possible imposition of the early withdrawal penalty, if the account is invested in a CD. (4) Written Formula: A SEPP is apparently created when the Employer effects a written document which establishes the rules with respect to participation, and a formula with which to determine the amount and method of allocating the Employer contributions. (5) Social Security Integration: As we are all aware (more painfully so in 1979), a part of each employee s salary is withheld and paid over to the government as the employee s contribution into the Social Security fund toward his future benefit. Some of you may not realize, however, that the Employer is required to make a matching payment into the same Social Security fund. Since this payment is being made toward his employees retirement benefit, the government allows the Employer to put provisions into certain types of retirement plans which take this type of "funding" into consideration. An Employer who establishes a SEPP may reduce the contribution he would otherwise make into the SEPP, by the amount paid into the employee s Social Security account for the year to which the SEPP contribution applies. If the Plan covers an owner-employee, the offset is only allowed if he makes a similar offset to the extent of his self-employment tax payment. For Example: Dr. X decided to establish a SEPP for herself & her two lab assistants. The Plan provides for a 15% contribution on behalf of all participants with a full Social Security offset. The two employees earn $10,000 and $12,000 and the doctor s net profit (before contributions) is $42,000. contribution on behalf of each employee is computed as follows: The *NOTE: 1979 FICA tax on the common-law employee s wages: 6.13% If a self-employed person were also receiving a salary as a commonlaw employee of another Employer, his self-employment tax is reduced to the extent that his other income is subject to FICA. The law, however, ignores the owner-employee s FICA covered income for purposes of integrating the SEPP. If this adjustment were allowed to be made for purposes of a SEPP, in most cases an owner-employee would get a disproportionately greater benefit. What if Dr. X (in the example above) was also an employee of a hospital, in addition to her private practice (the income upon which her self-employment tax is determined)? Had she been allowed to make this type of adjustment, she would be receiving a special benefit under her SEPP. For Example: Dr. X s compensation from the hospital As you can see, if the adjustment for FICA taxable wages were allowed to be made for this purpose, the owner-employee would receive a greater benefit. Rather than a deductible contribution of $4,152 in the previous example, she would be entitled to $5,610 resulting from the reduced adjustment from $1,855 to $397. Although an owneremployee is not allowed to take this adjustment into consideration, it should be noted that the adjustment would apply in the case of a self-employed individual with a 10% or less interest in a business. New Complexities and Costs Introduced by the SEPP As your author sees it, the basic problem is that the SEPP is an extension of the IRA. As you will recall, the IPC comments on this approach under the Bentsen bill were that these requirements should have been handled under $401 which deals with qualified plans, rather than under $408. In any event, there are several questions which immediately come to mind.... 1) The first is, how will the accounts be established? The |