What Is an SEP IRA?

A Simplified Employee Pension IRA allows employers to contribute to their employee’s traditional IRAs. The vehicle provides a substantial source of retirement income by permitting employers to put aside funds in retirement accounts for themselves and their workforce. Additionally, the plan simplifies contribution methods by delivering funds to each participant’s IRA. The SEP IRA also does not require start-up fees nor the operating costs common with conventional retirement plans.

An SEP IRA is available to any size business and established by adopting Form 5305-SEP with the Internal Revenue Service. There is no filing requirement for the employer and only the employer is allowed to contribute funds of up to 25 percent of the eligible employee's salary. Employers are not required to contribute every year; however, during years they choose to, they must contribute to not only their own SEP IRA, but also to every eligible employee's. Participating Employees must be entirely vested in all funds associated with a SEP IRA.

A SEP IRA is typically preferred by small business owners or self-employed individuals. Contributions to SEP IRAs are tax-deductible for the both the employee and the employer. Employees must be at least 21 years of age, employed by the company in three of the last five years and have earned at least $550 in the current year to be eligible for participation.

The primary drawback of the SEP IRA is that the employer must contribute equally to all eligible employee IRAs. There is also a 10 percent withdrawal penalty for employees under the age of 59 ½.