The IRS describes the Simplified Employee Pension, or SEP IRA, as an employer-sponsored retirement plan similar to a traditional IRA that a business of any size can establish. SEP IRAs are known for their low administrative costs, ease of operation and flexibility.
Under a SEP IRA, an employer must make discretionary contributions to all eligible employees regardless of the employee's wishes. Employer contributions are "free money" – contributions aren't part of a salary or included in the employee's taxable income the year of contribution. In addition, money in a SEP IRA grows tax-deferred until it's withdrawn in retirement.
SEP IRA Eligibility
Employers who establish a SEP IRA program for their employees must set up IRA accounts for all eligible employees. Employees become eligible when they turn 21 and have worked for the sponsoring employer for three of the last five years.
For the tax years 2021 and 2022, employees need to have compensation of at least $650 per year. As this is an employer-driven plan, employees aren't allowed to opt out of the plan, and the IRA must remain open until the employer terminates the plan or the employee leaves the company.
Employer Contributions
Employer SEP contribution are voluntary, so there's no annual requirement or minimum amount.
Typically, an employer makes an annual deposit equal to a percentage of compensation, based on the first $305,000 earned in 2022. This percentage must be equal for all employees. The IRS does set an annual maximum, which is the smaller of 25 percent of each eligible employee’s compensation or $61,000 for the 2022 tax year.
However, unlike SIMPLE IRAs or 401(k) plans, SEP IRAs don't allow employees to defer a portion of their salaries for pretax retirement savings. In addition, they are not allowed to make catch-up contributions.
According to the Department of Labor, if you are both employer and employee in your business, and receive compensation from it, you can contribute to a SEP fund on your own behalf. And in that case, you should base your compensation on your self-employment net earnings after deducting your SEP-IRA contributions and 50 percent of your self-employment taxes.
SEP Distribution Rules
Employer contributions are 100 percent vested to the employee at the time of deposit. This means that employees have complete control of the funds in their SEP IRAs and may take a distribution at any time. Distributions are taxed as part of the income for the year and are subject to an additional 10 percent IRS penalty if withdrawn prior to age 59 1/2.
Doing SEP IRA Rollovers
If you'd like more control over your investment options or wish to consolidate your retirement savings, SEP IRA funds may be rolled into other traditional IRAs while you're still employed. If you participate in a 401(k) plan with another employer, you may be able to roll your SEP IRA funds into that plan. It would be best to see your 401(k) plan sponsor for details.
You may also roll your SEP IRA fund into a Roth IRA, known as a Roth conversion. You must pay taxes on the amount you convert, but your savings grow tax-free, and earnings aren't subject to income tax if withdrawn according to IRS rules. See IRS Publication 590-b for complete Roth distribution rules.
