Simplified Employee Pension (SEP-IRA)

Simplified employee pensions (SEP), also known as SEP-IRAs (individual retirement accounts), can be defined as pension plans for successful small business people and me self-employed. Created by Congress and monitored carefully by the Internal Revenue Service, SEPs are designed to give small business owners and employees the same ability to set aside money for later retirement as traditional large corporate pension funds.

SEPs, however, can be much more flexible and attractive than corporate pensions. They can even be used to supplement the pension, and the corporate 401 (k) plans. Many full-time employed people use SEPs as a way to save and invest more money for retirement than they might normally be expected to put away under IRS rules. Forbes magazine described SEPs as a "moonlighter's delight" in a 1993 article. The reason for the magazine's enthusiasm is that SEPs, while created for the self-employed and small business people, also allow full-time employees to contribute a portion of self-employment income from consulting or freelancing.

The rules governing SEPs are fairly simple, but are subject to change with any Congressional action so yearly checks of IRS publications 560 (retirement plans for the self-employed) and 590 (IRAs) are necessary. Through 1994, SEPs could be set up with a simple form and did not require any separate trustee, which is required of larger, more complicated pension plans. The maximum allowable tax-deductible SEP contribution per employee is 15% of salary or income (up to a maximum income of $150,000) or $22,500, whichever is less. The maximum amount an employer can contribute to his or her own plan is 13,0435% of income. Still, compared to the $2,000 allowable standard IRA contribution, which has not been fully tax deductible for all contributors since 1986, the advantages of SEPs are obvious. Again on the plus side, people can contribute to their existing IRAs and 401(k)s, and still hold a SEP.

One word of caution for small business people: SEP plans must be set up for everyone in the company, not just the owners. That even includes part-time employees — everyone in the company must be covered. That does not mean that the SEP must be funded each year. If the company is experiencing a lean year funding of the SEP may be skipped. AD of the SEP's funding is deductible as a business expense in the year it is made.

A similar program is die salary reduction simplified employee pension (SARSEP). SARSEPs are similar to 401(k) plans, where employees defer part of their annual compensation into an IRA. Any employer contributions to the program are deductible as business expenses. The employer can still establish a separate SEP to handle employer contributions. SARSEPs are available to businesses with 25 or fewer employees, but at least 50% of the employees must elect to participate in the program to launch it.