A Simplified Employee Pension, or SEP, is a reasonably easy, low-cost way to provide retirement benefits, without committing the time and money of setting up and maintaining a qualified retirement plan. A SEP is similar to an IRA in that an employer makes contributions to his / her own IRA and the IRAs of his / her employees; however, contributions to each account can be much larger than the amount that can be contributed to a regular IRA.
There are numerous advantages to setting up a SEP. First, startup costs are generally low because a plan doesn’t have to be created from scratch. Next, participants may choose their own investments, and lastly, the plan sponsor does not have to make a contribution every year. If times are rough financially, and the plan sponsor cannot make a contribution in any particular year, he does not have to.
On the other hand, there are some disadvantages that SEPs feature. Contributions to a SEP made on behalf of employees are fully vested once the contributions are made. This can be a disadvantage, as gradual vesting can give employees more incentive to stay with the employer. Also, if the plan sponsor decides to make a contribution for a year, he must make a contribution for all qualifying employees. Generally, the same percentage must be contributed for other employees as the plan sponsor contributes for himself, because the plan sponsor cannot discriminate in favor of himself or highly compensated employees.
There are three basic steps in setting up a SEP. First, a formal agreement must be executed to provide benefits to all eligible employees. Second, each eligible employee must be given information regarding the SEP. Lastly, each eligible employee must set up a SEP-IRA or have one set up for them. An eligible employee is any individual who is 21 years of age, has worked for the plan sponsor three of the last five years, and has received at least $550 in compensation from employment in 2009 (this amount does not change in 2010.)
Contributions to a SEP-IRA cannot exceed the lesser of 25% of the employee’s compensation or $49,000 for 2009 (same for 2010). Compensation does not include the contributions made to a SEP-IRA.