The Simplified Employee Pension IRA, or SEP IRA, is designed for self-employed individuals and small-business owners and their employees. The SEP IRA functions essentially as a low-cost, easy-to-maintain pension plan for small businesses.

Before you establish a SEP IRA, you should consider that:

• Minimum IRS regulations require that employers include all eligible employees who are at least age 21 and have been with the company for three of the past five years.
• The same percentage of contribution must be made to all eligible employees.
• Money contributed by an employer belongs to the employee immediately.
• Employers are not required to make contributions in any given year or to maintain a certain level of contributions. This rule allows employers to adjust contributions based on business performance.

Contributions
Contribution limits for SEP IRAs are based on a couple of factors. The employer may contribute up to 25% of eligible compensation (if his or her modified adjusted gross income is less than $200,000) or $40,000—whichever is less*. In years that contributions are made to the employer's SEP IRA, contributions of an equal percentage must be made into all eligible employee accounts. Employees cannot contribute directly to a SEP IRA but are eligible to invest in a traditional or Roth IRA.

Unlike more formal pension plans, no vesting options exist for SEP IRAs. Once a contribution is made into a participant's account, it immediately belongs to the participant. If the employee leaves the company for any reason, all retirement contributions made on his or her behalf go with that person. This is known as portability.

Contributions may be made to SEP IRA accounts up to the tax-filing deadline for the business, including any extensions. Since filing dates vary based on how the business is registered, for instance sole proprietorship versus a corporation, it is important to consult a tax advisor about your specific situation.

Although the employer funds SEP IRAs, it is the employee's responsibility to complete the account application and select the funds to invest in. Employers may limit the number of funds available to employees to help simplify contribution paperwork, but employers are required to provide a range of investment choices to meet individual needs.

While a SEP IRA is not required to be reported on an annual tax return, be aware that each participant must receive a copy of the plan agreement and an annual report of contributions made to his or her account for the year.

NOTE: Please consult your tax professional regarding your specific needs.