Employer-provided retirement benefits are an important component in the three-prongs of retirement savings, with personal savings and Social Security accounting for the other two parts. Employers have a wide variety of options to provide retirement benefits and those options vary dramatically in cost, administrative oversight and type of benefit. Simplified Employee Pension plans offer employers a basic retirement plan that allows employees to save on a pre-tax basis.
What is a SEP?
A SEP is a less complex retirement plan that is available to employers of any size that do not want a costly or administratively burdensome retirement plan for their employees. The SEP is essentially an IRA to which the employer contributes for each eligible employee. These accounts are often called SEP-IRAs. Employees are always 100 percent vested in their SEP-IRA accounts.
Only employers are permitted to make contributions to SEPs. Unlike with traditional defined-benefit pension plans, employers are not required to contribute to the SEP-IRA each year; all contributions are discretionary. Employers also have flexibility in determining the amount to contribute as there are no required minimum contributions; however, employers must make equal contributions for all eligible employees.
Contributions to SEP-IRAs made by employers to eligible employees are done on a pre-tax basis and are not included in employees’ gross income. This rule does not apply if an employer contributes in excess of the SEP contribution limits as excess contributions will be included in employees’ incomes.
SEP Contribution Limits
While there are no minimum contributions to SEPs, there are limits to the amounts an employer may contribute to its employees’ accounts. The limit is indexed for inflation, and the IRS sets the limit each year. For 2012, employers are allowed to contribute up to 25 percent of an eligible employee’s compensation up to $50,000. Unlike with many retirement plans, employers are not permitted to make catch-up contributions for employees who are close to retirement age.
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