A simplified employee pension is a type of retirement plan that lets your company stash cash in an account in your name. Like with other IRA-based plans, you don't have to pay taxes on any investment gains until you tap into your nest egg during retirement. The contribution rules for SEP IRAs differ from those of other IRAs, which gives them some unique benefits and drawbacks.
The main advantage of a SEP IRA is that your employer contributes funds into your account for you. You are always 100 percent vested in the balance, meaning you always own all assets in your account. With other employer-offered retirement plans like 401(k)s, you usually have to sock away money yourself to get your employer to transfer cash to your account and you may not always be 100 percent vested. On the downside, your employer isn't required to contribute to a SEP IRA each year. If your company has a bad run, your account might not grow as quickly as you expected.
The government places strict limits on the amount you can invest in retirement accounts each year. As of 2013, the annual limit is $5,500 for traditional and Roth IRAs, or $6,500 if you are over age 50. SEP IRAs have a much higher limit -- your company can give you up to $51,000 a year. However, contributions are limited to 25 percent of your annual pay.
The biggest drawback of SEP IRAs is they do not allow for employee contributions. Other types of employer-offered plans like 401(k)s, 403(b)s and SIMPLE IRAs let you set aside a part of your paycheck before taxes. With a SEP, you rely entirely on your employer to sock away cash for you. However, your company can't decide to save on behalf of some workers and not others. It has to contribute to the accounts of all plan participants. Self-employed workers can set up SEP IRAs for their own benefit.
Cash you draw from a SEP IRA has to be included in your ordinary taxable income in the year you take it out. If you tap your account before age 59 1/2, you typically must pay a 10 percent early withdrawal penalty. You can avoid this if you become disabled, inherit an IRA or meet another exception. You are forced to begin taking withdrawals from your account starting at 70 1/2.
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