An IRA for Small Business
The Simplified Employee Pension Plan (SEP) plans enable small businesses to provide retirement benefits with lower costs and less reporting requirements than other qualified retirement plans. SEPs offer some attractive benefits for employers and employees alike.
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SEPs like typical IRAs but benefited by higher limit
A simplified employee pension plan is basically 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 the lesser of 25% of the employee's compensation or $40,000 per year. The company’s contributions are not counted as current income for the employee. SEP plans provide an effective retirement planning option for employees. They also provide the employer with an effective tax shelter.
SEPs can be funded like 401(k)s
Employees can also fund a SEP through a pre-tax salary reduction. Under a salary-reduction SEP, or SARSEP, employees can elect to defer up to $12,000 of their salary to the plan (in 2003). Employee funding further reduces costs to the employer. This salary-reduction feature enables a SEP to work much like a 401(k) plan. Note that no new SARSEP plans may be established after 1996, but contributions can continue to existing plans.
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SEPs are designed to provide a number of advantages. They have a significantly lower setup cost to the employer than regular pension or profit-sharing plans. They also offer simpler reporting and record-keeping requirements. For employees, SEPs offer substantially higher contribution limits than regular IRAs. This enables employees to accumulate more for retirement. In addition, the retirement benefits in a SEP are fully vested as soon as they are contributed. This makes a SEP completely portable. Departing employees can roll their SEP balances into an IRA or have them transferred to a retirement plan sponsored by their new employer.
Ultimately, simplified employee pensions can provide significant retirement benefits to employees while minimizing setup and administrative costs for employers.