What is a Simplified Employee Pension? Check Key Features, Eligibility & Exclusions of SEP IRA Pension Plan

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SEP-IRA or Simplified Employee Pension Individual Retirement Account is an individual retirement saving plan that benefits people who are self-employed or the ones who own small businesses. Let us take a detailed note of the plan in this post.  

So, what is an individual retirement account or IRA? An individual retirement account is a savings account that can be opened by self-employed people or the ones who earn income through small businesses. They can use this long-term account to save money for the future while enjoying tax benefits. This account especially suits the self-employed people with no access to other retirement accounts like 401(k) offered by employers.  The IRA can be purchased via banks, insurance companies, agents, insurance brokers and so on. Now, let us take a look at SEP meaning in the SEP IRA scheme.

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What is SEP?

SEP full form is Simplified Employee Pension. It is regarded as one of the good pension plans in the country, especially for self-employed individuals or employers who are willing to make tax-saving contributions for their workers.

The scheme also helps individuals to contribute a part of their earnings in a retirement plan with tax-deferred benefits. This contribution can further be invested in several assets to enhance the funds. So, the eligible individuals can avail the benefits of this simple and flexible SEP IRA account.

Key Features of SEP IRA Pension Plan

The table below mention the key features of the SEP IRA plan:

SEP Features

Details

Fund investment

Funds under this plan are invested in a variety of assets  

Easy to administer

These plans are easy to start and manage 

Tax benefits of the contributions made

The contributions made under the policy are tax deductible

Tax benefits at maturity

The funds earned under the plan are tax-deferred. Hence, they are not taxed until the money is withdrawn by the investor at retirement

Taxation policy

Investor can enjoy tax-deferred growth of the investment until maturity  

Vesting time is immediate

With immediate vesting time, employees can have complete ownership of the plan from the start 

loans/withdrawal

Not applicable

Administration process

Comparatively easy to set-up and manage as the plan require no annual filings

Eligibility Criteria of SEP IRA Pension Plan

So, what is the eligibility criteria to join a SEP Plan? Let us know about it in the table below:

Criteria 

Detail 

Business establishments 
  • Business firms
  • Single proprietors
  • LLCs
  • Associations
  • organisations
  • Non-profit/charitable organisations
For self-employed 
  • People who are self-employed (even if they have or don’t have any employees)
Employees 
  • Employees should be 21 years and above
  • The employee must have worked for the employer for 3 out of last 5 years

Exclusions in SEP IRA Plan

An employer can exclude the below employees from the SEP IRA plan:

  • If an employee is already covered under an agreement of collective bargaining
  • Non-residents with no source of income in the country
  • Those employees who have not completed a year of their service

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How Does SEP IRA Work?

To benefit from your SEP IRA plan, one must learn the functioning of the retirement plan well. So, check the points below for better guidance.

1. Plan establishment by employer

  • The employer starts separate SEP IRA accounts for each employee who is eligible
  • The employer also determines the amount to be contributed for each employee

2. Contributions to the Accounts 

  • Once the account is set up, the employer contributes for each of the account of the SEP IRA for employee
  • The contributions under the account are tax-exempted

3. SEP IRA Funds can be invested further

  • The employee can invest the SEP IRA funds in a variety of ways in several assets like bonds, stocks, mutual funds, ETFs or Exchange-Traded Funds etc.
  • The funds under this plan enjoy tax-deferred growth unless the employee withdraw them at retirement

4. Fund Withdrawal

  • The funds can be withdrawn by the employees from their SEP IRA account
  • The taxation of the withdrawal amount is done at the current tax slab rates like the way income of employees are taxed ordinarily

How to Establish a SEP IRA Plan?

Below are the steps to follow to set-up a SEP IRA Plan:

  • Check the eligibility of the business
  • Choose a bank/financial institution to buy the SEP IRA plan
  • Implement a plan document in written for SEP IRA to outline the plan terms like
  • Criteria of eligibility
  • Contributions to be made
  • Vesting time requirements
  • Let the employee know about the SEP IRA and its process of participation in written form
  • Start accounts separately for each eligible employee under the SEP IRA plan
  • Regulate the amounts of contributions for each of the eligible employee
  • Make the account contributions in the employee accounts before the year’s tax filing deadline
  • Keep the exact records of the contributions for a minimum of 6 years

Rules of SEP IRA

Here are some key rules of SEP IRA plans:

Rules 

Details 

Withdrawal 
  • Withdrawal is done as per the regular income tax slab rates
  • Penalty of 10% is applied in case of early withdrawal before retirement
Vesting 
  • Vesting period starts immediately after joining the plan
  • Employees knows the contributions made by the employer from the very beginning
Minimum distributions 
  • The required minimum distribution must be used from 72 years of age
Reporting by filing forms 
  • Employer has to file
  • Form 5305-SEP
  • Form 5305A-SEP
  • And written notice of SEP with complete detail
Plan management 
  • Make sure to comply by the rules and regulations
  • Keep records precisely
  • Stick to deadlines in terms of contributions

Differences Between SEP IRA and 401k Retirement Plan

SEP IRA and 401k are plans that allow tax benefits and serve as effective tools of savings for retirement. Here are some key differences between the two:

Criteria 

SEP IRA

401K

Eligibility 

Can be availed by self-employed individuals as well as small business holders

Can be availed by larger employers for their employees

Contributions 

Offer a contribution limit that is higher as compared to 401k

401k allows a lower contribution as compared to SEP IRA

Administration 

These are simple, manageable and less expensive

These are complex to start and manage

Participation of employee

Contributions are made only by the employers

Here, the employees can also contribute to the fund

Benefits of a SEP IRA Plan 

SEP IRA plans are retirement policies which aid both employers as well as the employees. Below are certain benefits of the plan:

  • The SEP IRA plans involve less paperwork and hence are easy to set up
  • The management expenses of these plans are comparatively low
  • The contributions made towards this plan are tax-deductible and reduce the taxable income of employers
  • The SEP IRA contribution limit made under the plans enjoy tax-deferred growth till the time of withdrawal, which helps the workers to accumulate better savings
  • Further, the SEP IRA allow higher contributions as compared to the traditional plans and help employees save more
  • Unlike in traditional plans, there is no age restriction for contributions made under a SEP IRA plan
  • The SEP IRA plans are portable and can be transferred by the employee in case of a job change
  • These plans give the freedom to the employers to decide the contribution amount done for each year in terms of profits

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To conclude 

SEP IRA plans are tax-advantaged plans for retirement savings used by owners of small businesses as well as self-employed people. An employer can contribute to the account for their employees as well as their own selves. The SEP IRA plans allow high limits of contribution along with immediate vesting and freedom. Further, these plans are easy to set-up and manage.

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FAQs: What is a simplified employee pension?

How much can you contribute to a SEP IRA account?

The contributions made to each employee's SEP-IRA account on a yearly basis cannot exceed the lesser of 25% of compensation, or $66,000 for 2023.

Are SEP IRA contributions tax deductible?

The contributions made under the policy by the employer are tax deductible.

What are the disadvantages of a SEP IRA?

Disadvantages of a SEP IRA is that the employees cannot make their own contributions under the SEP account.

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Jul 06, 2023
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PayBima is an Indian insurance aggregator on a mission to make insurance simple for people. PayBima is the Digital arm of the already established and trusted Mahindra Insurance Brokers Ltd., a reputed name in the insurance broking industry with 17 years of experience. PayBima promises you the easy-to-access online platform to buy insurance policies, and also extend their unrelented assistance with all your policy related queries and services.

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