Student Question from: Steve
Course:  Retirement Planning – SEP Employer Contributions

Student Question:

Dan, should the second paragraph below say, “…the lesser of 100% of covered compensation…”, and NOT 25%?  Thanks!   

While the funding amount can be at the sponsor’s discretion, the actual contribution structure is inflexible and is generally a uniform percentage of compensation.  Contributions cannot be made in favor of highly compensated employees.

The maximum annual contribution to an individual’s account is the Defined Contribution limit [i.e., the lesser of 25% of covered compensation or $50,000 (in 2012, as indexed)]. The plan formula can be integrated with Social Security.

Instructor Response:

Hey Steve,

This is among the most confusing “basic” rules out there!   All of these rules are why I hated this section when I was studying for the board exam back in the day.  Anyways, 25% is actually correct.  The maximum contribution to a SEP IRA is indeed the lesser of 25% of compensation or $51,000 (2013).  SEP IRA’s are not qualified plans. All SEP’s are SEP IRA’s.

The maximum contribution to a qualified defined contribution category plan is the lesser of 100% of compensation or $51,000 (2013).  Noteworthy, the plan sponsor can actually contribute more than the sponsor may deduct in most cases.  The sponsor of a qualified defined contribution plan may deduct only 25% of aggregate covered compensation. Covered compensation is compensation below the covered compensation limit of $255,000 in 2013.

Hope that helps!