A Simplified Employee Pension, or SEP, IRA is an employer-sponsored retirement plan. Under a SEP IRA, an employer must make discretionary contributions to all eligible employees regardless of the employee's wishes. Employer contributions are "free money" — contributions aren't part of a salary and they're not included in the employee's taxable income. In addition, money in a SEP IRA grows tax-free until it's withdrawn in retirement.
Employers who establish a SEP IRA program for their employees must set up IRA accounts for all eligible employees. Employees become eligible when they turn 21 and have worked in three of the last five years. In most cases, they need to have compensation of at least $550 per year. As this is an employer-driven plan, employees aren't allowed to opt out of the plan, and the IRA must remain open until the employer terminates the plan or the employee leaves the company.
Employers make contributions as they're able — there's no annual requirement or minimum amount. Typically, an employer makes an annual deposit equal to a percentage of compensation. This percentage must be equal for all employees. Unlike SIMPLE IRAs or 401k plans, SEP IRAs don't allow employees to defer a portion of their salaries for pretax retirement savings. SEP IRAs are traditional IRAs, however, so employees may be allowed to make regular IRA contributions into their SEP accounts. This feature varies by employer, so review your summary plan document for complete details.
Employer contributions are 100 percent vested to the employee at the time of deposit. This means that employees have complete control of the funds in their SEP IRAs and may take a distribution at any time. Distributions are taxed as part of the income for the year and are subject to a penalty if withdrawn prior to age 59 1/2.
If you'd like more control over your investment options or wish to consolidate your retirement savings, SEP IRA funds may be rolled into other traditional IRAs while you're still employed. If you participate in a 401k plan with another employer, you may be able to roll your SEP IRA funds into that plan — see your 401k plan sponsor for details. You may also roll your SEP IRA fund into a Roth IRA, known as a Roth conversion. You must pay taxes on the amount you convert, but your savings grow tax-free, and earnings aren't subject to income tax if withdrawn according to IRS rules. See IRS Publication 590 for complete Roth distribution rules.