What Is an SEP Account?
A Simplified Employee Pension (SEP) plan is essentially a fancy individual retirement arrangement (IRA) that allows small employers to sponsor a retirement plan for their employees that is easy to establish and also to administer. The costs associated with an SEP make it very attractive to small businesses. SEPs allow small businesses to offer a benefit to their employees while also receiving a tax deduction on their contributions.
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Basics
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An employer may establish an SEP by creating a written plan document. The Internal Revenue Service (IRS) has created a model SEP, so it is very easy to create a plan document, thereby establishing an SEP. Employers then contribute directly to an SEP on behalf of their employees.
Participation
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Employers must contribute to the SEP of each individual they employ who has reached age 21, has performed service for the employer during at least three of the immediately preceding five years and who has received at least $450 in compensation from the employer for the year.
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Contributions
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Employers may not discriminate in favor of highly compensated employees. The employer's contributions must bear a uniform relationship to employees' total compensation. These contributions must be made under a written allocation formula, which specifies the requirements that an employee must satisfy to share in an allocation and the manner in which the allocation is computed. These contributions are not required to be fixed, which is a concept that is similar to a profit-sharing retirement plan.
An employer may contribute up to the lesser of $49,000 or 25 percent of the employee's compensation.
Withdrawals
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The employer may not impose any prohibitions on withdrawals from the SEP; however, the Internal Revenue Code contains penalties for early withdrawals. Withdrawals are considered early if an employee receives a distribution prior to the date on which he reaches age 59 1/2. The penalty for an early withdrawal is a 10-percent additional tax on the portion of the amount that is included in gross income.
There are certain exceptions to the penalty for early withdrawals: distributions made to a beneficiary on or after the death of the employee; if the employee becomes disabled; if the distribution is made to the employee after separation from service after reaching age 55; or if the distribution is made on account of a tax levy in accordance with federal law.
Benefits
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An employer can establish an SEP very easily as the IRS has established a model plan document. For this reason, an SEP is an attractive option for small businesses as attorneys are not needed to draft a plan document and it is much cheaper to establish than other retirement benefit plans. Moreover, employees bear all of the investment risk as they select the funds their SEP account is invested in.
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