Finance Terms: Simplified Employee Pension (SEP)

A piggy bank with a sep label on it

As a small business owner or an employee, planning for retirement should be on your list of priorities. One of the investment options to consider is Simplified Employee Pension (SEP), which is a retirement plan that allows employers to contribute to their employees’ retirement accounts. In this article, we will give a detailed explanation of what SEP is, its benefits, and how to set it up.

What is a Simplified Employee Pension (SEP)?

A SEP plan is an employer-sponsored retirement plan that allows contributions made by an employer to their employees’ retirement accounts. The contributions are tax-deductible and grow tax-free until the employee withdraws. The plan is often chosen by small business owners who want to invest their money in retirement savings while minimizing costs and administrative hassle.

SEP plans have a high contribution limit, which makes them an attractive option for employers who want to contribute more to their employees’ retirement accounts. In 2021, the contribution limit is 25% of an employee’s compensation or $58,000, whichever is less. This means that an employer can contribute up to $58,000 to an employee’s SEP account in a year.

Another advantage of SEP plans is that they are easy to set up and maintain. Unlike other retirement plans, such as 401(k) plans, SEP plans do not require annual filings with the IRS. This makes them a popular choice for small business owners who do not have a dedicated HR department or a lot of resources to devote to retirement plan administration.

Understanding the Benefits of SEP for Employers and Employees

The benefits of SEP are numerous. First, as an employer, you can contribute up to 25% of an employee’s compensation to their retirement account, subject to an annual limit of $58,000 (2021). This amount is much higher than what is allowed in traditional IRAs. Secondly, SEP allows employers to claim a tax deduction for their contributions made to employees’ retirement accounts. As an employee, your SEP IRA account grows tax-deferred until you start taking distributions.

Another benefit of SEP for employers is that it is easy to set up and maintain. Unlike other retirement plans, SEP does not require annual filings or complex administrative tasks. This makes it a cost-effective option for small businesses that do not have a dedicated HR department.

For employees, SEP offers flexibility in terms of contributions. Unlike 401(k) plans, where the employer sets the contribution amount, SEP allows employees to contribute to their own retirement account. This means that employees can choose to contribute more to their retirement savings, which can help them achieve their retirement goals faster.

Who is Eligible for a Simplified Employee Pension (SEP)?

Any business owner, partnership, or self-employed individual can establish a SEP plan for themselves and their employees. Only employees who are at least 21 years old, have worked for the employer for three of the last five years, and received at least $600 in compensation are eligible to participate in the plan. SEP plans are ideal for small businesses because they are easy to set up and administer.

SEP plans offer several benefits to both employers and employees. For employers, contributions to a SEP plan are tax-deductible, and the plan is easy to set up and maintain. For employees, contributions to a SEP plan are made on a pre-tax basis, reducing their taxable income. Additionally, SEP plans offer flexibility in terms of contribution amounts, allowing employers to adjust contributions each year based on business performance. Overall, a SEP plan can be a valuable tool for small businesses looking to provide retirement benefits to their employees while also receiving tax benefits.

How to Set Up a SEP Plan for Your Small Business

The first step to setting up a SEP plan is to adopt a written SEP agreement. The agreement document outlines the terms and conditions of the plan and must be signed by the employer. Next, the employer must give each eligible employee a copy of the SEP agreement and a disclosure statement explaining the plan’s terms. The employer must also open a SEP IRA account for each employee using a qualified financial institution such as a bank, mutual fund, or brokerage firm.

Once the SEP IRA accounts have been established, the employer must make contributions to the accounts on behalf of the employees. The contributions are typically a percentage of the employee’s compensation and must be made by the employer’s tax-filing deadline, including extensions. The employer can deduct the contributions as a business expense on their tax return.

It’s important to note that SEP plans have contribution limits, which are subject to change each year. Employers should stay up-to-date on the current limits and ensure they are not contributing more than the allowed amount. Additionally, employers should regularly review the plan’s performance and make any necessary adjustments to ensure it is meeting the needs of both the business and its employees.

SEP Contribution Limits: What You Need to Know

The maximum annual contribution for SEP plans is 25% of an employee’s compensation or $58,000 (2021), whichever is less. The contribution limit may change each year, so it’s essential to stay up-to-date with any changes. The contributions made by the employer are tax-deductible for the employer, and the funds grow tax-deferred until the funds are withdrawn.

It’s important to note that SEP plans are designed for small business owners and self-employed individuals. These plans offer a simple and flexible way to save for retirement, with lower administrative costs compared to other retirement plans. Additionally, SEP plans allow for contributions to be made up until the employer’s tax-filing deadline, including extensions. This means that if you file for an extension, you have until October 15th to make contributions for the previous tax year. Overall, SEP plans can be a great option for those looking to save for retirement while also receiving tax benefits.

Advantages and Disadvantages of Choosing a SEP Plan

One advantage of SEP plans is that they are easy to set up, have low administrative fees, and have high contribution limits. SEP plans are also available to self-employed individuals and partnerships. However, employes might not be happy with the employer’s discretionary contribution rates, which depend on the employer’s preference and financial sustainability.

Another disadvantage of SEP plans is that they do not allow for catch-up contributions for employees over the age of 50, unlike other retirement plans such as 401(k)s. Additionally, SEP plans require employers to contribute the same percentage of salary for all eligible employees, which may not be feasible for small businesses with fluctuating profits. It is important for employers to carefully consider the pros and cons of SEP plans before deciding if it is the right retirement plan for their business.

SEP vs 401(k): Which Retirement Plan is Right for You?

Choosing between a SEP plan and a 401(k) plan can be a challenging decision. SEP plans are suitable for smaller businesses with fewer employees and do not require as much administrative work as 401(k) plans. On the other hand, 401(k) plans are more complex but offer employees the ability to make contributions from their own salaries and have higher contribution limits.

It is important to consider the needs and goals of your business when deciding between a SEP plan and a 401(k) plan. If your business has a small number of employees and you want to keep administrative work to a minimum, a SEP plan may be the better option. However, if you want to offer your employees the opportunity to save more for retirement and are willing to invest more time and resources into managing the plan, a 401(k) plan may be the way to go. Ultimately, it is important to consult with a financial advisor to determine which plan is best suited for your business and employees.

How to Calculate Your SEP IRA Contribution

Calculating your SEP IRA contribution involves multiplying your net income by the contribution percentage provided in your SEP plan agreement.

It is important to note that the contribution percentage cannot exceed 25% of your net income. For example, if your net income is $100,000 and your SEP plan agreement specifies a contribution percentage of 20%, your maximum contribution for the year would be $20,000. Additionally, if you are self-employed, you can deduct your SEP IRA contributions from your taxable income, which can result in significant tax savings.

Tips for Maximizing Your SEP IRA Contributions

Contributing the maximum allowable amount to a SEP IRA plan can help ensure that you have the funds necessary to support your retirement. Some tips for maximizing your contributions include setting up automatic contributions, contributing lump sums whenever possible, and choosing investments that align with your investment goals.

Another important tip for maximizing your SEP IRA contributions is to take advantage of catch-up contributions if you are over the age of 50. Catch-up contributions allow you to contribute an additional $1,000 per year to your SEP IRA plan, on top of the regular contribution limit. This can help you make up for any lost time in saving for retirement and increase your overall retirement savings.

Tax Implications of SEP IRA Withdrawals

Withdrawals are taxable and may be subject to a 10% early withdrawal penalty if taken before you reach age 59 and a half. The employer contribution is taxed in the year you withdraw funds and at the employee’s marginal tax rate, which is higher than the tax rate on capital gains.

It is important to note that if you withdraw funds from your SEP IRA before the age of 70 and a half, you will be required to take minimum distributions each year. Failure to take these distributions can result in a penalty of up to 50% of the amount that should have been withdrawn.

Additionally, if you inherit a SEP IRA, the tax implications may be different. As a non-spouse beneficiary, you may be required to take distributions over a shorter period of time, which could result in higher taxes. It is important to consult with a financial advisor or tax professional to understand the specific tax implications of inheriting a SEP IRA.

How to Roll Over Your SEP IRA into Another Retirement Account

Rolling over your SEP IRA into another account is a simple process. You can roll it into a traditional IRA, a 401(k), or another SEP IRA. The important thing to keep in mind is to avoid having to take the money out of your account by ensuring that the rollover is completed within the 60-day limit after receiving the distribution.

Before initiating a rollover, it is important to consider the fees and expenses associated with the new account. Some accounts may have higher fees or require a minimum balance, which could impact your retirement savings in the long run. It is also important to research the investment options available in the new account to ensure they align with your retirement goals and risk tolerance.

Additionally, if you are considering rolling over your SEP IRA into a 401(k) with a new employer, it is important to check if the new plan accepts rollovers and if there are any restrictions or limitations. Some plans may only allow rollovers from certain types of retirement accounts or may require a waiting period before you can make contributions or withdrawals.

Common Mistakes to Avoid When Managing Your SEP IRA

Some mistakes to avoid when managing your SEP IRA include failing to timely complete the required documentation, failing to make contributions on time, or failing to complete necessary distributions. You should always keep detailed records of contributions and any other transactions in your account.

Another common mistake to avoid is contributing more than the maximum allowed amount. For 2021, the maximum contribution limit for a SEP IRA is $58,000 or 25% of your compensation, whichever is less. Exceeding this limit can result in penalties and tax consequences.

It is also important to regularly review and adjust your investment strategy. Failing to do so can result in missed opportunities for growth or exposure to unnecessary risk. Consider consulting with a financial advisor to ensure your investment strategy aligns with your long-term goals.

Top Providers for Simplified Employee Pension (SEP) Plans

The top providers for SEP plans include Fidelity, Vanguard, Schwab, and TD Ameritrade. These providers offer affordable plans, easy access, and robust support for their clients.

It is important to note that while these providers are among the top for SEP plans, it is always recommended to do your own research and compare plans before making a decision. Factors such as fees, investment options, and customer service should all be taken into consideration when choosing a provider for your SEP plan.


SEP plans are an excellent option for small business owners, self-employed individuals, and partnerships willing to set up a retirement plan that is easy to administer, has low fees, and offers high contribution limits. Understanding what SEP plans are, their benefits, how to set them up, and the common mistakes to avoid will enable you to optimize your retirement savings and avoid penalties.

One of the advantages of SEP plans is that they allow for flexible contributions. Employers can choose to contribute different amounts each year, depending on their financial situation. This can be particularly helpful for businesses that experience fluctuations in revenue or profits.

Another benefit of SEP plans is that they are relatively easy to set up and maintain. Unlike other retirement plans, such as 401(k)s, SEP plans do not require annual filings with the IRS. This can save business owners time and money, as they do not need to hire a third-party administrator to handle the paperwork.

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