SEP-IRA: An Alternative to 401K Plans

For an updated list of available retirement plans and annual plan limits, reference our employee retirement plan chart.

As unemployment in this competitive job market remains at a record low, potential employees are looking for benefits like 401K plans. Unfortunately, the mandatory annual employer contributions of most pension plans can be cost-prohibitive for many small businesses. For these firms, there is at least one realistic option: almost everyone should be able to take advantage of SEP IRAs.

Since 1979, businesses have been able to establish Simplified Employee Pension Individual Retirement Accounts (SEP IRA) for their employees. Essentially, it's an IRA with a twist-in addition to allowing employees to contribute to the IRA, an employer can, too.

What's the lure of these plans? They cost nothing but time to set up, and employers are not required to contribute. Moreover, SEP-IRAs are easier to set up and maintain than most retirement plans. The sole requirement is to fill out an adoption agreement, which is a far simpler agreement than those found with other plans. Employers need to make only two decisions: who will be eligible to participate, and what formula will be used to allocate the funds they choose to contribute ($100 per month, for example, or a percentage of salary).

Also, employers receive a tax deduction for any contributions they make to their employees' SEP-IRAs for the tax year in which the contribution was made. Contributions max out at 15% of a participant's salary (or $24,000, whichever is less).

To establish a SEP-IRA, you can obtain adoption agreement kits free of charge from the IRS, mutual fund companies, brokerage firms, or banks. There is usually a section in the back of each kit called the SEP Plan Document that covers the nitty gritty of the decisions that need to be made. It's worth noting that the adoption agreement must be executed by the employer's tax filing deadline, plus extensions.

be paid by the employee; employers might want to pick up this cost as a gesture of goodwill. if the company you approach asks for an additional fee on top of the trustee fee, find someone else-there are plenty of companies that do this for free.

SEP-IRAs are not perfect, though. From the employee's perspective, SEP-IRAs omit a key advantage of the more complex retirement plans: the ability to contribute pre-tax income to their account. Instead, employees must rely only on the generosity of their employer, who can contribute on a pre-tax basis.

From the employer's point of view, the plan doesn't necessarily incent employees to save for the future as features like matching contributions don't exist. In addition, participants become fully vested immediately- once a contribution has been made to the participant's account, it belongs to them. This just means that you'll need to find other ways to ensure that employees will stick around.

Quick tips

Fair enough. All retirement plans require that employer contributions be consistent across all employees. No playing favorites here.

IRA cap. As with an individual IRA, an employee can contribute a maximum of $2,000 to their fund.

Investment flexibility. When checking options, see if employees have full flexibility about where they can invest their funds. Not every company does.