- An SEP is a tax-advantaged retirement plan that is established by an employer for the benefit of the employee. The employer can make contributions to his own account, and self-employed taxpayers can establish an SEP for their own benefit. An SEP operates under same basic tax regulations as a traditional Individual Retirement Account. Contributions are made with pretax dollars, funds within each individual's SEP IRA grow on a tax-deferred basis, and qualified withdrawals are taxed at the individual taxpayer's then current tax rate as ordinary income.
- Every eligible employee benefits from the establishment of an SEP. Eligible employees include those who are at least 21 years old, earned at least $550 during the previous tax year (as of 2010), and have been employed with the employer for at least three of the past five years; the three years do not need to be consecutive. The employer must set up a separate SEP IRA for each eligible employee. The SEP IRA is owned and controlled by the employee. Employer contributions to the employee's SEP IRA are 100 percent vested as soon as they are made.
- Employers gain the benefit of deciding whether or not to make contributions to the SEP IRA for any given year. This flexibility helps employers to conserve cash flow during lean years, while being able to contribute larger amounts during prosperous years. Employer contributions must be made to all eligible employees based on a written formula that is fair to all employees. Employers benefit because they can deduct the amount they contribute to their employee's SEP IRAs, and employees benefit because these contributions are not counted as taxable income until they are withdrawn.
- The employee owns the SEP IRA account and can control, within certain perimeters, how funds in the account are invested. The employee benefits by getting tax-deferred growth on the funds in the account. The employee can make withdrawals from her SEP IRA without incurring a tax penalty at any time after she reaches age 59 1/2. The employee benefits from having the option of accessing funds in her SEP IRA account at any time to meet emergency situations, although funds withdrawn prior to reaching age 59 1/2 will be taxed as ordinary income and be subject to a 10-percent tax penalty.
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