Small businesses or the self-employed with one or more employees looking for an easy retirement plan to set up for their employees can establish a SEP (Simplified Employee Pension) account. A SEP is a written arrangement that provides the employer with an easy way to make contributions to an employee’s retirement income. Under a SEP, contributions are made to a traditional IRA, not a ROTH or SIMPLE IRA. The Employer does not have an annual filing requirement but must use the IRS form 5305- SEP (a two page form) to set up the plan.
The employee does not contribute to the plan like in a traditional IRA or 401k. Instead, the only contributions made are from the employer. This is good for a seasonal employer or one with erratic changes in cash flow because they don’t have to make contributions every year however they must make the same percentage contributions to all eligible employees when they do make a contribution. For example, all employees will receive 10% of their salary. Minimum employee coverage requirements are that the employee must be 21 years of age, employed for at least 3 out of last 5 years and had compensation of at least $550 in 2011. Less restrictive requirements can be established but they can be no more restrictive than these. Contribution amounts cannot exceed 25% of compensation or more than $49,000 for 2011. Contributions are immediately vested at 100% but will be subject to federal income taxes on withdrawals and penalties plus tax on early withdrawals.
The best part about the SEP is that the contributions may be deducted in the tax year for which the contributions are made from the employers’ tax return. This is a win-win situation for the employer and employee. The employee gets money deposited into their IRA, and the employer offers the employees a low-maintenance retirement benefit.
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