What Is a SEP IRA?

An SEP (Simplified Employee Pension) IRA is a traditional IRA for small business owners or self-employed individuals, which allows for the same tax-deferred benefits when planning for retirement.

As its name suggests, SEP offers an easy way for employers to contribute to the retirement savings for themselves and their employees. Each participant makes payments to an individually set up IRA or Annuity, and an SEP-IRA adheres to the same investment, distribution, and rollover rules, according to the IRS.

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Any business owner or freelancer can establish a SEP IRA, including sole proprietorships, partnerships, corporations and non-profit organizations. Money is invested in the same manner, since the accounts are considered IRAs. Contributors face the same deadline as an employer's tax return, including extensions.

According to Investopedia, one bonus of the SEP plan is that employees can "use the same account to which SEP contributions are made for their regular Traditional IRA contributions."

An employee who is at least 21-years-old, has worked three of the past five years for the employer and has earned at least $550 per year is generally eligible to participate for the current year.

A SEP doesn't come with the start-up and operating costs associated with a conventional retirement plan and contributors can allocate up to 25 percent of each employee's pay.

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Because SEP IRA contributions are immediately 100 percent vested, employees can take contributions at any time, regardless of whether the employee is still on the employer's payroll.

The distributions rules for a SEP IRA are the same as a Traditional IRA, and must eventually be taken, though only some are mandatory. Any taxes or penalties applied to distributions from a traditional IRA are based on the holder's age at the time of the distribution.

For example, distributions taken before age 59 and a half are subject to a 10 percent early-distribution penalty, on top of any income tax.

There are instances where someone can take a penalty-free distribution, such as paying for medical insurance, purchasing a first home or paying a beneficiary.

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