Q: What is a SEP IRA?

A: A SEP IRA is a Simplified Employee Pension (SEP) IRA. SEPs were authorized by Congress in 1978 to provide employers with a simpler, less complicated manner of providing retirement benefits for themselves and their employees.
A SEP is a written arrangement (a Plan) that allows an employer (including a self-employed individual) to make contributions towards its employees’ retirement without becoming involved in more complex retirement plans. A SEP must satisfy the requirements set forth in Internal
Revenue Code (IRC) section 408(k), as well as the top-heavy requirements of IRC section 416 and the limitations on annual additions under IRC section 415. The contributions are made to traditional Individual Retirement Arrangements (not Roth or SIMPLE IRAs) of the plan participants. Under a SEP, IRAs are set up for each eligible employee.

Simplified Employee Pensions with a Salary Reduction Arrangement (SARSEPs) are defined in IRC section 408(k)(6). A SARSEP is a SEP that includes a salary reduction arrangement. Under this type of arrangement, the employee can elect to contribute part of his or her pay to the SEP. The SBJPA prospectively repealed SARSEPs. No new SARSEPs can be established after December 31, 1996. However, employers that established SARSEPs prior to January 1, 1997, can continue to maintain them, and new employees of the employer hired after December 31, 1996 can participate in the existing SARSEP.

Only an employer can set up a SEP. A self-employed individual may establish a SEP for himself/herself and his/her employees. A sole proprietor (an individual who owns the entire interest in an unincorporated trade or business) may establish a SEP for himself/herself. A partnership may establish a SEP because the partnership is treated as the employer of each partner. Compensation would include the earned income of the sole proprietor (or partner).

SEPs can be established for a particular year after that year has ended. They can be established as late as the latest time prescribed by law for making deductible employer contributions (that is, no later than the due date, including extensions, of the employer’s return for the year). This is more generous than the rule for qualified plans under IRC section 401(a). A qualified plan must be executed by the end of the taxable year for which the employer wants to take a deduction.

For more information on SEP IRA’s, visit http://www.irs.gov/pub/irs-tege/epch1502.pdf