Monday, July 20, 2009

How is a SEP Different from an IRA or 401(k)?

Simplified employee pensions (SEPs), while not technically qualified employer-sponsored plans, provide the opportunity for employers to make contributions to employee IRAs. Employees own and manage their own SEPs, so the employer’s administrative cost is minimal. Additionally, employers offering SEPs are not required to make set or recurring contributions to employee plans, so contributions can be made at the employer’s discretion. However, all employer SEP-IRA contributions must be made to each eligible employee and the same percentage of compensation must be contributed for each individual.

SEPs offer several unique advantages. An employer offering a SEP can contribute and deduct as much as 25 percent of its covered payroll. Further, the contribution limit for individual employees is relatively high – 25 percent of compensation up to a maximum of $49,000. SEP benefits make the plan attractive to small businesses and self-employed individuals.

Again, SEPs are only investment vehicles, and participants must choose underlying investments to purchase for their accounts. SEP contributions are deductible on the employee’s income tax return, and investments inside a SEP will grow tax deferred. Funds distributed from a SEP are considered ordinary income. Generally, distributions from a SEP before the employee turns 59.5 will suffer a 10 percent penalty.

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