As another alternative to the 401(k) plan, a Simplified Employee Pension plan (or SEP for short) can be a very powerful, user-friendly option. This employer-sponsored plan is easy to open and administer and also limits administrative fees and expenses. With these plans, the employer contributes a percentage of each eligible employee’s salary. These contributions are made with pre-tax dollars and must be made by the due date for the employer’s federal income tax return – including any extensions.

How much must the employer contribute on an annual basis? The answer is nothing. However, the employer must make a matching contribution for each and every eligible employee when they do contribute. That said, the employer may choose to not contribute in any plan year. This provides flexibility for the employer from a cash flow perspective. How much can an employer contribute? Contributions for eligible employees must stay below the lesser of either 25% of compensation or $53,000. This number is subject to annual cost of living adjustments per IRS guidelines.

SEP contributions are made into each eligible employee’s Traditional IRA account and are immediately 100% vested. Depending on the set up, employees may, separately from the SEP, make contributions to the same Traditional IRA account. For example, Sally has an annual salary of $42,000. Her employer, Trademarks Inc., has established a SEP and wants to provide a contribution to all eligible employees of 3% this plan year. So, when the contributions are made, Sally will receive a contribution of $1,260 from Trademarks Inc. into her Traditional IRA for her SEP. Separately, she would like to take advantage of the ability to contribute to a Traditional IRA. This year Sally would like to contribute the maximum allowed. She is 44 years old, so she is able to contribute $5,500 into the Traditional IRA. So, total contributions into her traditional IRA for 2016 would be $6,760.

Consider utilizing a SEP when you’d like to provide a simplified retirement benefit for employees but are unsure how much you can afford from year to year. In a good year, contribute a larger percentage of each employee’s income. On a not so good year, contribute a smaller percentage or no percentage at all. There are other plans that allow for this flexibility, but they come with increased administration, recording keeping, and responsibility, which generally means increased expenses.