Simplified Employee Pension Plans (SEPs)

If you're a small business owner thinking about adopting a retirement plan, you should consider a SEP (simplified employee pension plan). A SEP allows you to make retirement contributions to traditional IRAs (SEP-IRAs) set up for yourself and each eligible employee. (If you don't have employees, you can adopt a SEP for yourself alone.) Your contributions are deductible from your business's income, and excluded from your employees' income. Virtually any business owner can establish a SEP.

What are some advantages of a SEP?

• Fairly high contribution limits. For 2012, you can contribute and deduct up to 25% of each employee's W-2 compensation (up to $250,000, $245,000 in 2011). If you're self-employed, the contribution to your IRA can't exceed 20% of your net earnings from self-employment. Contributions can't exceed $50,000 per participant ($49,000 in 2011).
• You don't have to make contributions to the SEP every year. However, if you do make a contribution, you must generally contribute a uniform percent of pay for yourself and each eligible employee.
• You have until the due date of your business's federal income tax return (including extensions) to set up a SEP and make contributions.
• SEPs are fairly easy to set up and inexpensive to operate. You can establish a SEP by using a simple two-page IRS document (Form 5305-SEP), or by adopting a prepackaged prototype SEP from a bank, insurance company, or financial institution.
• Reporting requirements are minimal.
• A SEP doesn't preclude you or your employees from establishing or contributing to a separate IRA. (However, participation in the SEP may impact whether or not annual traditional IRA contributions are deductible.)
• Employer contributions can be made after age 70½.
• Generally, you won't have fiduciary responsibility for your employees' investment decisions.

What are some disadvantages?

• All employees must be included in the SEP except employees who have not attained age 21, haven't worked for you in at least three of the last five years, or earn less than $550.
• Your contributions vest immediately. This can be costly if you have high employee turnover.
• Unlike a 401(k) plan, employees can't make pretax contributions or Roth contributions to a SEP (but a SEP can accept annual and rollover IRA contributions, like any other traditional IRA).
• Plan loans are not allowed.
• A SEP-IRA may provide less protection from creditors outside of bankruptcy than some other alternatives.

What are my options?

A number of other types of retirement plans are available to small business owners, including 401(k) plans, profit-sharing plans, defined benefit plans, and SIMPLE IRAs.

If you have no employees (other than your spouse) and don't anticipate having any in the near future, a solo 401(k) plan may be a better choice, as it may allow a higher deductible contribution than a SEP. For example, if you're incorporated, you can receive an employer contribution of up to 25% of your W-2 income (to $250,000 in 2012, $245,000 in 2011) (like a SEP) but in addition, you can make up to $17,000 ($16,500 in 2011) of pretax employee contributions (plus an additional $5,500 of catch-up contributions if you're age 50 or older). Total contributions (employer and employee) are limited to $50,000 in 2012 ($49,000 in 2011), plus any catch-up contributions (or, if less, 100% of your compensation).

Unlike a SEP, a solo 401(k) can allow plan loans and Roth contributions. And because a solo 401(k) doesn't cover any common law employees, it's simpler to administer than a regular 401(k) plan (because the Employee Retirement Income Security Act of 1974 (ERISA) does not apply).