SEP IRASEP IRA is a Simplified Employee Pension Individual Retirement Account, and derived its name based on the fact that it is simple. The purpose of the SEP IRA is to provide an IRA that functions in a similar manner to a pension for use by small business employers and self-employed workers. It’s flexible enough that it can be rolled over into a different form of IRA if employment changes or the owner becomes eligible for a different plan. Because it is designed primarily for the small business, the administrative costs of the SEP IRA are low, and for the self-employed there are normally no costs at all for administration of the account.

Major requirement of the SEP IRA regarding the benefits:

A business with employees must provide the same benefits to all employees. To qualify for the SEP IRA under employee participation, that employee must be over 21 years old and been employed for three of the last five years, earning at least $450 of wages in the previous year. In a SEP IRA, the employer makes contributions to the plan from the employee’s earnings, up to 25% of the employee’s total income. This portion of the employee’s earnings deposited into the SEP IRA can save on taxes and is deductible.

For the self-employed individual, the contribution limit is 20% of earnings and the maximum annual limit is approximately 18.6% of the net profit as calculated on his self-employed worker tax form. Distributions from a SEP IRA mirror those from a Traditional IRA. Disbursements are taxed at the prevailing tax rate at the time of withdrawal and subject to penalty if withdrawals are taken before age 59 ½. Distributions from the account must begin by age 70 ½.  For the small business that wants to provide a retirement plan for employees but does not have the resources to fund a conventional plan, the SEP IRA provides a retirement safety net for the business and its workers.

Flexibility of the SEP IRA:

The SEP IRA appeals to many business owners because, unlike other types of IRA accounts, there is no set obligation for contributions. The employer is allowed to alter the amount and frequency of plan contributions based on profitability of the business, and can make these changes annually. If the company is a start-up with smaller profits, the employer simply sets up the SEP IRA with a modest employer match. As the business grows and profits become larger, the plan can be changed to larger contributions. If the business has a few years of struggle, contributions can be reduced until things pick up again. A business will appreciate the ease of setting up the SEP IRA, done easily with a two page form. Each employee completes an investment application that is provided by the company that holds the investment funds. There is no required reporting to the IRS on annual returns, so the small business can easily manage the entire process.

Most small businesses choose to have their plan held by larger mutual fund companies, allowing their employees to select how they want to invest their money and eliminating the choice of investments from the employer’s responsibilities. The individual employees decide for themselves. Owners of small businesses appreciate the fact that with a SEP IRA plan, they can offer their employees a retirement plan as part of the benefit package, and perhaps attract a higher caliber worker to a smaller company. Employees benefit as well, aided by their SEP IRA contributions building retirement security for them. The SEP IRA is simple to understand, easy to administer, and an excellent resource for small businesses and the people those businesses employ.

For more information, see SEP IRA Account and SEP IRA Limits
Also see:  SEP IRA on Wikipedia
Photo courtesy of Salvatore Vuono