Simplified Employee Pension (SEP)

A simplified employee pension (SEP) is a written arrangement that allows your employer to make deductible contributions to a traditional IRA (a SEP-IRA) set up for you to receive such contributions. See chapter 3 for more information about SEPs.

Required Disclosures

The trustee or issuer (sometimes called the sponsor) of your traditional IRA generally must give you a disclosure statement at least 7 days before you set up your IRA. However, the sponsor does not have to give you the statement until the date you set up (or purchase, if earlier) your IRA, provided you are given at least 7 days from that date to revoke the IRA.

The disclosure statement must explain certain items in plain language. For example, the statement should explain when and how you can revoke the IRA, and include the name, address, and telephone number of the person to receive the notice of cancellation. This explanation must appear at the beginning of the disclosure statement.

If you revoke your IRA within the revocation period, the sponsor must return to you the entire amount you paid. The sponsor must report on the appropriate IRS forms both your contribution to the IRA (unless it was made by a trustee-to-trustee transfer) and the amount returned to you. These requirements apply to all sponsors.

How Much Can Be Contributed?

There are limits and other rules that affect the amount that can be contributed to a traditional IRA. These limits and rules are explained below.

Community property laws. Except as discussed below under Spousal IRA Limit, each spouse figures his or her limit separately, using his or her own compensation. This is the rule even in states with community property laws.

Brokers' commissions. Brokers' commissions paid in connection with your traditional IRA are subject to the contribution limit. For information about whether you can deduct brokers' commissions, see Brokers' commissions, later under How Much Can I Deduct.

Trustees' fees. Trustees' administrative fees are not subject to the contribution limit. For information about whether you can deduct trustees' fees, see Trustees' fees, later under How Much Can I Deduct.

Contributions on your behalf to a traditional IRA reduce your limit for contributions to a Roth IRA. See chapter 2 for information about Roth IRAs.

General Limit

The most that can be contributed to your traditional IRA is the smaller of the following amounts:

• Your compensation (defined earlier) that you must include in income for the year, or
• $3,000 ($3,500 if you are 50 or older).

Note. This limit is reduced by any contributions to a section 501(c)(18) plan (generally, a pension plan created before June 25, 1959, that is funded entirely by employee contributions).

This is the most that can be contributed regardless of whether the contributions are to one or more traditional IRAs or whether all or part of the contributions are nondeductible. (See Nondeductible Contributions, later.)

Examples. George, who is 34 years old and single, earns $24,000 in 2002. His IRA contributions for 2002 are limited to $3,000.

Danny, a college student working part time, earns $1,500 in 2002. His IRA contributions for 2002 are limited to $1,500, the amount of his compensation.

More than one IRA. If you have more than one IRA, the limit applies to the total contributions made on your behalf to all your traditional IRAs for the year.

Annuity or endowment contracts. If you invest in an annuity or endowment contract under an individual retirement annuity, no more than $3,000 ($3,500 if 50 or older) can be contributed toward its cost for the tax year, including the cost of life insurance coverage. If more than this amount is contributed, the annuity or endowment contract is disqualified.

Spousal IRA Limit

If you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your IRA is the smaller of the following two amounts:

1. $3,000 ($3,500 if you are 50 or older), or
2. The total compensation includable in the gross income of both you and your spouse for the year, reduced by the following two amounts.
   1. Your spouse's IRA contribution for the year to a traditional IRA.
   2. Any contributions for the year to a Roth IRA on behalf of your spouse.

This means that the total combined contributions that can be made for the year to your IRA and your spouse's IRA can be as much as $6,000 ($6,500 if only one of you is 50 or older or $7,000 if both of you are 50 or older).

Note. This traditional IRA limit is reduced by any contributions to a section 501(c)(18) plan (generally, a pension plan created before June 25, 1959, that is funded entirely by employee contributions).

Example. Kristin, a full-time student with no taxable compensation, marries Jeremy during the year. Neither will be 50 by the end of the year. For the year, Jeremy has taxable compensation of $30,000. He plans to contribute (and deduct) $3,000 to a traditional IRA. If he and Kristin file a joint return, each can contribute $3,000 to a traditional IRA. This is because Kristin, who has no compensation, can add Jeremy's compensation, reduced by the amount of his IRA contribution, ($30,000 - $3,000 = $27,000) to her own compensation (-0-) to figure her maximum contribution to a traditional IRA. In her case, $3,000 is her contribution limit, because $3,000 is less than $27,000 (her compensation for purposes of figuring her contribution limit).

Filing Status

Generally, except as discussed earlier under Spousal IRA Limit, your filing status has no effect on the amount of allowable contributions to your traditional IRA. However, if during the year either you or your spouse was covered by a retirement plan at work, your deduction may be reduced or eliminated, depending on your filing status and income. See How Much Can I Deduct, later.

Example. Tom and Darcy are married and both are 53. They both work and each has a traditional IRA. Tom earned $1,800 and Darcy earned $48,000 in 2002. Because of the spousal IRA limit rule, even though Tom earned less than $3,500, they can contribute up to $3,500 to his IRA for 2002 if they file a joint return. They can contribute up to $3,500 to Darcy's IRA. If they file separate returns, the amount that can be contributed to Tom's IRA is limited to $1,800.

Less Than Maximum Contributions

If contributions to your traditional IRA for a year were less than the limit, you cannot contribute more in a later year to make up the difference.

Example. Justin, who is 40, earns $30,000 in 2002. Although he can contribute up to $3,000 for 2002, he contributes only $1,000. After April 15, 2003, Justin cannot make up the difference between his actual contributions for 2002 ($1,000) and his 2002 limit ($3,000). He cannot contribute $2,000 more than the limit for any later year.

More Than Maximum Contributions

If contributions to your IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year. However, a penalty may apply. See Excess Contributions, later under What Acts Result in Penalties or Additional Taxes.

When Can Contributions
Be Made?

As soon as you set up your traditional IRA, contributions can be made to it through your chosen sponsor (trustee or other administrator). Contributions must be in the form of money (cash, check, or money order). Property cannot be contributed. However, you may be able to transfer or roll over certain property from one retirement plan to another. See the discussion of rollovers and other transfers later in this chapter under Can I Move Retirement Plan Assets.

Contributions can be made to your traditional IRA for each year that you receive compensation and have not reached age 70 1/2. For any year in which you do not work, contributions cannot be made to your IRA unless you receive alimony or file a joint return with a spouse who has compensation. See Who Can Set Up a Traditional IRA, earlier. Even if contributions cannot be made for the current year, the amounts contributed for years in which you did qualify can remain in your IRA. Contributions can resume for any years that you qualify.

Contributions must be made by due date. Contributions can be made to your traditional IRA for a year at any time during the year or by the due date for filing your return for that year, not including extensions. For most people, this means that contributions for 2002 must be made by April 15, 2003.

Age 70 1/2 rule. Contributions cannot be made to your traditional IRA for the year in which you reach age 70 1/2 or for any later year.

Designating year for which contribution is made. If an amount is contributed to your traditional IRA between January 1 and April 15, you should tell the sponsor which year (the current year or the previous year) the contribution is for. If you do not tell the sponsor which year it is for, the sponsor can assume, and report to the IRS, that the contribution is for the current year (the year the sponsor received it).

Filing before a contribution is made. You can file your return claiming a traditional IRA contribution before the contribution is actually made. However, the contribution must be made by the due date of your return, not including extensions.

Contributions not required. You do not have to contribute to your traditional IRA for every tax year, even if you can.

How Much Can I Deduct?

Generally, you can deduct the lesser of:

1. The contributions to your traditional IRA for the year, or
2. The general limit (or the spousal IRA limit, if applicable) explained earlier under How Much Can Be Contributed.

However, if you or your spouse was covered by an employer retirement plan, you may not be able to deduct this amount. See Limit If Covered By Employer Plan, later. You may be able to claim a credit for contributions to your traditional IRA. For more information, see chapter 5.

Trustees' fees. Trustees' administrative fees that are billed separately and paid in connection with your traditional IRA are not deductible as IRA contributions. However, they may be deductible as a miscellaneous itemized deduction on Schedule A (Form 1040). For information about miscellaneous itemized deductions, see Publication 529, Miscellaneous Deductions.

Brokers' commissions. These commissions are part of your IRA contribution and, as such, are deductible subject to the limits.

Full deduction. If neither you nor your spouse was covered for any part of the year by an employer retirement plan, you can take a deduction for total contributions to one or more of your traditional IRAs of up to the lesser of:

1. $3,000 ($3,500 if you are 50 or older), or
2. 100% of your compensation.

This limit is reduced by any contributions made to a 501(c)(18) plan on your behalf. Spousal IRA. In the case of a married couple with unequal compensation who file a joint return, the deduction for contributions to the traditional IRA of the spouse with less compensation is limited to the lesser of:

1. $3,000 ($3,500 if 50 or older), or
2. The total compensation includible in the gross income of both spouses for the year reduced by the following two amounts.
   1. The IRA deduction for the year of the spouse with the greater compensation.
   2. Any contributions for the year to a Roth IRA on behalf of the spouse with the greater compensation.

This limit is reduced by any contributions to a section 501(c)(18) plan on behalf of the spouse with less compensation. Note. If you were divorced or legally separated (and did not remarry) before the end of the year, you cannot deduct any contributions to your spouse's IRA. After a divorce or legal separation, you can deduct only the contributions to your own IRA and your deductions are subject to the rules for single individuals.

Covered by an employer retirement plan. If you or your spouse was covered by an employer retirement plan at any time during the year for which contributions were made, your deduction may be further limited. This is discussed later under Limit If Covered By Employer Plan. Limits on the amount you can deduct do not affect the amount that can be contributed.

Are You Covered
by an Employer Plan?

The Form W-2 you receive from your employer has a box used to indicate whether you were covered for the year. The Retirement Plan box should be checked if you were covered.

Reservists and volunteer firefighters should also see Situations in Which You Are Not Covered, later.

If you are not certain whether you were covered by your employer's retirement plan, you should ask your employer.

Federal judges. For purposes of the IRA deduction, federal judges are covered by an employer plan.

For Which Year(s) Are You Covered?

Special rules apply to determine the tax years for which you are covered by an employer plan. These rules differ depending on whether the plan is a defined contribution plan or a defined benefit plan.

Tax year. Your tax year is the annual accounting period you use to keep records and report income and expenses on your income tax return. For most people, the tax year is the calendar year.

Defined contribution plan. Generally, you are covered by a defined contribution plan for a tax year if amounts are contributed or allocated to your account for the plan year that ends with or within that tax year. However, also see Situations in Which You Are Not Covered, later.

A defined contribution plan is a plan that provides for a separate account for each person covered by the plan. In a defined contribution plan, the amount to be contributed to each participant's account is spelled out in the plan. The level of benefits actually provided to a participant depends on the total amount contributed to that participant's account and any earnings on those contributions. Types of defined contribution plans include profit-sharing plans, stock bonus plans, and money purchase pension plans.

Example. Company A has a money purchase pension plan. Its plan year is from July 1 to June 30. The plan provides that contributions must be allocated as of June 30. Bob, an employee, leaves Company A on December 31, 2001. The contribution for the plan year ending on June 30, 2002, is made February 15, 2003. Because an amount is contributed to Bob's account for the plan year, Bob is covered by the plan for his 2002 tax year.

No vested interest. If an amount is allocated to your account for a plan year, you are covered by that plan even if you have no vested interest in (legal right to) the account.

Defined benefit plan. If you are eligible to participate in your employer's defined benefit plan for the plan year that ends within your tax year, you are covered by the plan. This rule applies even if you:

• Declined to participate in the plan,
• Did not make a required contribution, or
• Did not perform the minimum service required to accrue a benefit for the year.

A defined benefit plan is any plan that is not a defined contribution plan. In a defined benefit plan, the level of benefits to be provided to each participant is spelled out in the plan. The plan administrator figures the amount needed to provide those benefits and those amounts are contributed to the plan. Defined benefit plans include pension plans and annuity plans.

Example. Nick, an employee of Company B, is eligible to participate in Company B's defined benefit plan, which has a July 1 to June 30 plan year. Nick leaves Company B on December 31, 2001. Since Nick is eligible to participate in the plan for its year ending June 30, 2002, he is covered by the plan for his 2002 tax year.

No vested interest. If you accrue a benefit for a plan year, you are covered by that plan even if you have no vested interest in (legal right to) the accrual.

Situations in Which You Are Not Covered

Unless you are covered by another employer plan, you are not covered by an employer plan if you are in one of the situations described below.

Social security or railroad retirement. Coverage under social security or railroad retirement is not coverage under an employer retirement plan.

Benefits from previous employer's plan. If you receive retirement benefits from a previous employer's plan, you are not covered by that plan.

Reservists. If the only reason you participate in a plan is because you are a member of a reserve unit of the armed forces, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.

1. The plan you participate in is established for its employees by:
   1. The United States,
   2. A state or political subdivision of a state, or
   3. An instrumentality of either (a) or (b) above.
2. You did not serve more than 90 days on active duty during the year (not counting duty for training).

Volunteer firefighters. If the only reason you participate in a plan is because you are a volunteer firefighter, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.

1. The plan you participate in is established for its employees by:
   1. The United States,
   2. A state or political subdivision of a state, or
   3. An instrumentality of either (a) or (b) above.
2. Your accrued retirement benefits at the beginning of the year will not provide more than $1,800 per year at retirement.

Limit If Covered By Employer Plan

As discussed earlier, the deduction you can take for contributions made to your traditional IRA depends on whether you or your spouse was covered for any part of the year by an employer retirement plan. Your deduction is also affected by how much income you had and by your filing status. Your deduction may also be affected by social security benefits you received.

Reduced or no deduction. If either you or your spouse was covered by an employer retirement plan, you may be entitled to only a partial (reduced) deduction or no deduction at all, depending on your income and your filing status.

Your deduction begins to decrease (phase out) when your income rises above a certain amount and is eliminated altogether when it reaches a higher amount. These amounts vary depending on your filing status.

To determine if your deduction is subject to the phaseout, you must determine your modified adjusted gross income (AGI) and your filing status, as explained under Deduction Phaseout. Once you have determined your modified AGI and your filing status, you can use Table 1-2 or Table 1-3 to determine if the phaseout applies.

Social Security Recipients

Instead of using Table 1-2 or Table 1-3 and Worksheet 1-2, Figuring Your Reduced IRA Deduction for 2002, later, complete the worksheets in Appendix B of this publication if, for the year, all of the following apply.

• You received social security benefits.
• You received taxable compensation.
• Contributions were made to your traditional IRA.
• You or your spouse was covered by an employer retirement plan.

Use the worksheets in Appendix B to figure your IRA deduction, your nondeductible contribution, and the taxable portion, if any, of your social security benefits. Appendix B includes an example with filled-in worksheets to assist you.

Table 1-2. Effect of Modified AGI ¹ on Deduction if Covered by Retirement Plan at Work

If you are covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.

IF your filing status is ...	AND your modified adjusted gross income (modified AGI) is ...	THEN you can take ...
single or head of household	less than $34,000	a full deduction.
	at least $34,000 but less than $44,000	a partial deduction.
	$44,000 or more	no deduction.
married filing jointly or qualifying widow(er)	less than $54,000	a full deduction.
	at least $54,000 but less than $64,000	a partial deduction.
	$64,000 or more	no deduction.
married filing separately 2	less than $10,000	a partial deduction.
	$10,000 or more	no deduction.

1 Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI). 2 If you did not live with your spouse at any time during the year, your filing status is considered Single for this purpose (therefore, your IRA deduction is determined under the Single column).

Table 1-3. Effect of Modified AGI ¹ on Deduction if NOT Covered by Retirement Plan at Work

If you are not covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.

IF your filing status is ...	AND your modified adjusted gross income (modified AGI) is ...	THEN you can take ...
single, head of household, or qualifying widow(er)	any amount	a full deduction.
married filing jointly or separately with a spouse who is not covered by a plan at work	any amount	a full deduction.
married filing jointly with a spouse whois covered by a plan at work	less than $150,000	a full deduction.
	at least $150,000 but less than $160,000	a partial deduction.
	$160,000 or more	no deduction.
married filing separately with a spouse who is covered by a plan at work 2	less than $10,000	a partial deduction.
	$10,000 or more	no deduction.

1 Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI). 2 You are entitled to the full deduction if you did not live with your spouse at any time during the year.

Deduction Phaseout

The amount of any reduction in the limit on your IRA deduction (phaseout) depends on whether you or your spouse was covered by an employer retirement plan.

If you were covered. If you were covered by an employer retirement plan and you did not receive any social security retirement benefits, your IRA deduction may be reduced or eliminated depending on your filing status and modified AGI, as shown in Table 1-2.

For 2003, if you are covered by a retirement plan at work, your IRA deduction will not be reduced (phased out) unless your modified AGI is between:

• $40,000 and $50,000 for a single individual (or head of household),
• $60,000 and $70,000 for a married couple filing a joint return (or a qualifying widow(er)), or
• $-0- and $10,000 for a married individual filing a separate return.

For all filing statuses other than married filing separately, the upper and lower limits of the phaseout range will increase by $6,000.

If your spouse is covered. If you are not covered by an employer retirement plan, but your spouse is, and you did not receive any social security benefits, your IRA deduction may be reduced or eliminated entirely depending on your filing status and modified AGI as shown in Table 1-3.

Filing status. Your filing status depends primarily on your marital status. For this purpose you need to know if your filing status is single or head of household, married filing jointly or qualifying widow(er), or married filing separately. If you need more information on filing status, see Publication 501, Exemptions, Standard Deduction, and Filing Information.

Lived apart from spouse. If you did not live with your spouse at any time during the year and you file a separate return, your filing status, for this purpose, is single.

Modified adjusted gross income (AGI). You can use Worksheet 1-1 to figure your modified AGI. If you made contributions to your IRA for 2002 and received a distribution from your IRA in 2002, see Both contributions for 2002 and distributions in 2002, later.

Do not assume that your modified AGI is the same as your compensation. Your modified AGI may include income in addition to your compensation such as interest, dividends, and income from IRA distributions.

Form 1040. If you file Form 1040, refigure the amount on the page 1 adjusted gross income line without taking into account any of the following amounts.

• IRA deduction.
• Student loan interest deduction.
• Tuition and fees deduction.
• Foreign earned income exclusion.
• Foreign housing exclusion or deduction.
• Exclusion of qualified savings bond interest shown on Form 8815.
• Exclusion of employer-paid adoption expenses shown on Form 8839.

This is your modified AGI. Form 1040A. If you file Form 1040A, refigure the amount on the page 1 adjusted gross income line without taking into account any of the following amounts.

• IRA deduction.
• Student loan interest deduction.
• Tuition and fees deduction.
• Exclusion of qualified bond interest shown on Form 8815.
• Exclusion of employer-paid adoption expenses shown on Form 8839.

This is your modified AGI. Income from IRA distributions. If you received distributions in 2002 from one or more traditional IRAs and your traditional IRAs include only deductible contributions, the distributions are fully taxable.

Both contributions for 2002 and distributions in 2002. If all three of the following occurred, any IRA distributions you received in 2002 may be partly tax free and partly taxable.

1. You received distributions in 2002 from one or more traditional IRAs, and
2. You made contributions to a traditional IRA for 2002, and
3. Some of those contributions may be nondeductible contributions depending on whether your IRA deduction for 2002 is reduced.

If all three of the above occurred, you must figure the taxable part of the traditional IRA distribution before you can figure your modified AGI. To do this, you can use Worksheet 1-3, Figuring the Taxable Part of Your IRA Distribution. If at least one of the above did not occur, figure your modified AGI using Worksheet 1-1.

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