Simplified Employee Pension

Picking a retirement plan when you're your own boss

Question: I'm self-employed doing Web site design. I've been told before about Simplified Employee Pensions, or SEPs, and heard they're somewhat similar to IRAs. Could you explain whether it would be advantageous for me to look into this, and what drawbacks, if any, there are? Right now, I just have a Roth IRA, to which I contribute the maximum each year.

Answer: It is all too easy and far too common to kick the savings can down the street, especially when you work for yourself. But not only are you already actively saving, you are thinking about ways to save more. Bravo.

And I have good and bad news for you. The good is there are attractive options for the self-employed to save for retirement. The bad is that thinking about the different options can feel like an alphabet soup that has turned evil. But let me see if I can help a bit.

There are three primary savings instruments for the self-employed. You mentioned the SEP. In addition, there is also the Individual 401(k) and the SIMPLE IRA. There is a fourth option, a qualified defined benefit plan, but it is much more complicated and costly to administer and typically only attractive to very high-income older people. Because of that, let's focus on the other three.

The SIMPLE IRA is the Savings Investment Match Plan for Employees Individual Retirement Account. Quite a mouthful. For most self-employed people, this is the least attractive option. It mandates an employer contribution — 2 percent or 3 percent of an employee's salary — which can be tough if times get lean. Of the three options, it allows the least to be saved tax-free. This plan tends to be more beneficial to a small employer that wants employees to do most of the contributing out of their own pocket. For a self-employed person, the other options are probably better.

One such option is the one you mentioned, the SEP. It is really the SEP-IRA (Simplified Employee Pension-Individual Retirement Account). Its name is a bit misleading because it is not a "pension" as commonly understood in which you get a monthly check of some amount paid to you in retirement. Rather, the SEP-IRA is really just an account, a place to stash money to prevent it from being taxed very similar to any other IRA or even a 401(k) account. And in the case of the SEP-IRA, the employer is the entity making the entire contribution. The employee cannot contribute. Now, for a self-employed person that distinction might seem a bit odd, but because the SEP-IRA can be used for a small business that has employees, it is an important distinction.

SEP – simplified employee pension plan | Accounting portal

A SEP is a simplified employee pension plan. A SEP plan provides employers with a simplified method to make contributions toward their employees’ retirement and, if self-employed, their own retirement. Contributions are made directly to an Individual Retirement Account or Annuity (IRA) set up for each employee (a SEP-IRA). See Publication 560 for detailed SEP information for employers and employees.

A SEP is established by adopting a SEP agreement and having eligible employees establish SEP-IRAs. There are three basic steps in setting up a SEP, all of which must be satisfied.

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