Simplified employee pension (SEP) plans make it possible for small businesses to provide retirement benefits with lower costs and less reporting requirements than other qualified retirement plans. In fact, SEPs offer some attractive benefits for employers and employees alike.

How Do SEPs Work?

A simplified employee pension plan is essentially nothing more than a group of individual retirement accounts maintained for employees.

Under a typical SEP plan, the employer establishes IRAs for all participating employees. The employer then contributes to the IRAs, subject to the contribution limits for SEPs not IRAs. Employer contributions are limited to $40,000 per year without being counted as current income for the employee.

SEP plans provide an effective retirement planning option for employees. They also provide the employer with a legal and effective tax shelter.

Salary-Reduction Option

Employees can fund a SEP through a pre-tax salary reduction. Under a salary-reduction SEP, or SARSEP, employees can elect to defer up to $11,000 of their salary to the plan (as of 2002). Employee funding has the added benefit of reducing costs to the employer.

This salary-reduction feature enables a SEP to work much like a 401(k) plan. No new SARSEP plans are allowed to be established after 1996, but if you have one, you may continue to make contributions to the existing plan.

Advantages

SEPs were designed to provide a number of advantages.

There is a significantly lower setup cost to the employer than regular pension or profit-sharing plans. The reporting and record-keeping requirements are simpler.

For employees, SEPs allow significantly higher contribution limits than regular IRAs. This enables employees to accumulate more for retirement.

The retirement benefits in a SEP are fully vested as soon as they are contributed making the SEP completely portable. Employees who change employers can roll their SEP balances into an IRA or transfer them to a retirement plan sponsored by their new employer.

Simplified employee pensions have the ability to provide significant retirement benefits to employees while minimizing setup and administrative costs for employers.