Simplified Employee Pension (SEP) IRA
Simplified Employee Pension (SEP) plans can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee's pay.
- Available to any size business
- Easily established by adopting Form 5305-SEP, a SEP prototype or an individually designed plan document
- If Form 5305-SEP is used, cannot have any other retirement plan (except another SEP)
- No filing requirement for the employer
- Only the employer contributes
- To traditional IRAs (SEP-IRAs) set up for each eligible employee
- Employee is always 100% vested in (or, has ownership of) all SEP-IRA money
What Are Simplified Employee Pensions?
Some employers hesitate to establish a qualified employee retirement arrangement because of the administrative hassles and expense. An attractive alternative is a simplified employee pension, or SEP. SEPs are an effective way to provide employee retirement benefits with a minimum of paperwork and reporting requirements.
SEPs may be suitable for employers who don’t want to be locked in to making contributions every year. The employer can choose to contribute or not based on business performance and capital needs.
How Do They Work?
Under a SEP arrangement, the employer makes contributions to individual retirement accounts and/or individual retirement annuities (IRAs) that have been established for eligible employees. The employer has three options when setting up the SEP: adopt an IRS model agreement, use a financial institution’s prototype or create a custom-designed SEP (with IRS approval).
Eligible employees must be allowed to participate in the SEP. To be eligible, the employee must have:
- Reached age 21.
- Worked for the employer for at least three of the past five years.
- Received at least $750 (for 2025) in compensation from the employer.
These requirements must be met in each year that the company makes a contribution for the employee.
What Are the Contribution Limits?
An employer can make deductible contributions to an employee’s SEP-IRA up to certain limits. In 2025, contributions must be the lesser of 25% of the employee’s compensation (not exceeding $350,000) or a specified dollar limit ($70,000). For more information on Contribution Limits, visit: https://www.irs.gov/retirement-plans/plan-participant-employee/sep-contribution-limits-including-grandfathered-sarseps
A SEP doesn’t allow contributions that discriminate in favor of highly compensated employees.
All contributions are fully vested in the employee, who can withdraw the money at any time. Withdrawals are taxed as ordinary income when they are received, and an additional 10% penalty tax may apply to distributions taken before age 591⁄2 unless certain exceptions apply.
Participants must begin receiving payments—at least a minimum required amount—by April 1 of the year following the calendar year in which they reach 73. A 25% penalty tax applies to any amount that should have been paid out but wasn’t (10% if the distribution error is corrected quickly).
What’s the Conclusion?
A SEP gives employers the opportunity to boost employee morale and improve retention by establishing a retirement benefit without taking on the administrative headaches of other types of retirement plans. A SEP requires minimal paperwork, reporting and bookkeeping, with the flexibility to decide whether and how much to contribute each year. Employer contributions are also tax deductible. Employees benefit as a result of tax-deferred contributions and earnings.
Pros and Cons:
- Easy to set up and operate
- Low administrative costs
- Flexible annual contributions – good plan if cash flow is an issue
- Employer must contribute equally for all eligible employees
Who Contributes: Employer contributions only.
Contribution Limits: Total contributions to each employee's SEP-IRA are limited.
Filing Requirements: An employer generally has no filing requirements.
Participant Loans: Not permitted. The assets may not be used as collateral.
In-Service Withdrawals: Yes, but includible in income and subject to a 10% additional tax if under age 59 1/2.
For further reading, feel free to visit: https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep
This information is not intended as authoritative guidance or tax or legal advice. You should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.