What is an SEP IRA?

Did you know there are several types of Individual Retirement Accounts or IRAs?  Some are established by the individual and others are sponsored by employers, usually with matching contributions.  A SEP IRA is one particular type of IRA that is ideal for small business owners looking for an alternative to standard profit sharing retirement plans.

The simplicity of an SEP IRA

The acronym SEP stands for Simplified Employee Pension.  An employer deposits contributions into an IRA account that belongs to the participant employee.  This is different from other employer-sponsored IRAs, where the contributions are deposited into an employer trust account.

A SEP makes the accounting process much easier, as it does not require an extensive written legal document.  Nor does it have as many compliance reporting and disclosure requirements as other plans.  A SEP IRA also has very minimal administrative costs.

Advantages of SEP IRAs

First, there are various tax benefits available with SEP IRAs.  The contributions are tax deductible to the employer.  The earnings are tax deferred for the employee.  SEP IRAs also provide flexibility with regard to contributions.  Employers can make annual discretionary contributions of up to 25% of the employee’s compensation.

Unlike profit sharing plans and other pensions, an SEP IRA can be created at any time up to the deadline for tax filing, including periods of extension.  This makes tax planning and investment strategies very flexible.

Establishing an SEP IRA

Sole proprietorships, partnerships, corporations and some tax-exempt organizations are the most common types of business that use SEP plans.  The employer executes an SEP plan document provided by the SEP IRA custodian.

Then, each employee who is eligible opens a separate SEP IRA account at whatever institution he or she chooses.  The employer can then make contributions on behalf of the employee to the account.

Contributions and participant eligibility

Although an SEP IRA is funded by the employer, it is considered 100% vested in the employee at all times.  This year, 2015, the maximum contribution amount for an SEP is either 25% of the employee’s compensation or $53,000, whichever is less.

In order for an employee to be eligible for participation in an SEP IRA, the employee must be at least 21 years of age and have worked for the company in any three years in the prior five year period.  This applies to both full-time and part-time employees alike.  An employer can decide to set a less restrictive age or service requirement, as long as the rules of eligibility are applied consistently to every employee, including owners who are employed as well.

If you have questions regarding an SEP IRA, or any other retirement planning needs, please contact Wilcox Attorneys, PA online or by calling us at (479) 443-0062.