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What Is a Simplified Employee Pension (SEP) Plan?
An SEP is a retirement plan established by employers, including self-employed individuals (sole proprietorships or partnerships). The SEP is an IRA-based plan to which employers may make tax-deductible contributions on behalf of eligible employees. The employer is allowed a tax deduction for plan contributions, which are made to each eligible employee's SEP IRA on a discretionary basis.
Employees do not pay taxes on SEP contributions, but these contributions are taxed when the employee receives a distribution from the SEP IRA.
An employee (including the business owner) who is eligible to participate in his or her employer's SEP plan must establish a Traditional IRA to which the employer will deposit SEP contributions. Some financial institutions require the Traditional IRA to be labeled as an SEP IRA before they will allow the account to receive SEP contributions. Others will allow SEP contributions to be deposited to a Traditional IRA regardless of whether or not the IRA is labeled as a SEP IRA. Because the funding vehicle for a SEP plan is a Traditional IRA, SEP contributions, once deposited, become Traditional IRA assets and are subject to many of the Traditional IRA rules, including the following:
- Distribution rules
- Investment rules
- Contribution and deduction rules for Traditional IRA contributions - These apply to the employee's regular IRA contributions, not the SEP-employer contributions.
- Documentation requirements for establishing an IRA - In addition to the documents required for establishing a SEP plan (discussed later), each SEP IRA must meet the documentation requirement for a Traditional IRA.
These rules are explained in the tutorial Traditional IRAs.
Next: SEP IRAs: Eligibility Requirements |
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