Use of the word “simple” to describe a retirement plan might seem an odd choice, but as part of "SEP IRA" it is appropriate: SEP stands for Simplified Employee Pension. Even though SEP IRAs are designed for small business owners and self-employed persons, any employer may set one up. An employer who establishes a SEP IRA for an employee makes contributions directly to the account.
Setting One Up
To establish a SEP IRA, you must execute a formal written agreement, provide all eligible employees with information regarding the SEP and set up a SEP IRA account for each eligible employee. Any person who is 21 years of age or older, has worked for you in at least three of the past five years and who has received an IRS-specified minimum amount of wages in each of the most recent two years, including the current year (as of the date of publication, the amount is $550 for 2011 and 2012) is considered an eligible employee. Even if you already have a retirement plan through an employer, you may still establish a SEP for yourself if you also receive self-employment income.
The contribution limit for a SEP IRA is the lesser of 25 percent of earnings or a specified dollar amount -- $49,000 for 2011 and $50,000 for 2012. An employer must contribute to each employee's SEP the same percentage of wages. Annual contributions are not required, so an employer who has a lean year may elect not to contribute -- or he may make a smaller contribution. If the employer chooses to contribute to his own SEP, he must contribute to the SEPs of all employees.
Why Do It
Unlike other retirement plans, such as a 401(k), an SEP does not cost anything to set up or operate. Contributions are tax-deductible and earnings are not taxed. In addition, a SEP requires the filing of no annual reports with the IRS.
Participants in a SEP may withdraw money at any time to roll it into another SEP, a traditional IRA or another employer’s retirement plan that allows it. Withdrawals not rolled into another retirement account will be taxed, and if you are younger than 59 1/2 when you make a withdrawal, you must pay a 10 percent penalty. You may not take out a loan from a SEP.
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