What Is a Simplified Employee Pension (SEP)?

For small business owners, making significant contributions towards employee retirement can be a challenge. Simplified Employee Pension (SEP) plans can be a great savings option.

With SEP plans, the employer makes direct contributions to the employees’ IRA accounts. Employers can also contribute to their own SEP-IRA if they receive compensation from the business. SEPs are also simpler than most other retirement benefit options and require nominal startup investment.

Here are some of the key advantages offered by SEPs:

  • SEP plans do not require mandatory annual contributions. Employers can decide the amount of contribution based on the financial status of the business. In a bad year, employers can choose not to contribute at all. However, the contribution rate for all employees must remain uniform.
  • Contributions made to SEP are tax-free, and the business does not pay any taxes on the investment earnings.
  • The SEP option is available to different business structures, including partnerships, sole proprietorships, as well as large corporations.
  • Administrative costs associated with SEP are quite low.
  • For the first three years, a business may receive a tax credit of up to $500 per year.
  • SEP plans generally does not involve filing any documents with the government.

The working of a SEP plan is very straightforward. Usually, the financial institutions chosen as trustees for SEPs have numerous investment funds, giving employees a choice. The financial institution will handle government reporting and annual statements to the employees.

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Here’s an overview of rules that apply to SEP-IRAs:

  • A 10 percent tax generally applies to money withdrawn before age 59-1/2.
  • Participants must start withdrawing a specified minimum amount after they reach age 70-1/2. For more specifics, please refer to the Dept. of Labor (DOL) website.

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This article is updated from its original publication date of June 29, 2012.

This is not intended as legal advice; for more information, please click here.

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