The plan has high contribution allowances. Employers can make tax-deductible plan contributions – up to 25 percent of income or $49,000 (for 2009), whichever is less – to each eligible employee’s SEP IRA on a discretionary basis.

Once deposited, the SEP IRA contributions become traditional IRA assets and are subject to many of the rules governing traditional IRAs. Its funds can be invested the same way as any other IRA funds. SEP IRA contributions are tax-free and investment earnings are tax-deferred. Contributions are taxed when the employee receives a distribution from the SEP IRA.

Withdrawals after age 59½ are taxed as ordinary income. A 10 percent IRS penalty may also be charged on top of the income taxes for withdrawals made before age 59½. However, it can be rolled over tax-free to another SEP IRA, traditional IRA or another employer’s qualified retirement plan.

Under a SEP IRA plan, all employees must receive the same benefits. The maximum annual compensation on which contributions can be based is $245,000 for 2009.

SEP IRA plans are ideal for self-employed individuals and small businesses because they are easy to administer. Generally, it does not require the filing of any documents with the government. Additionally, its startup and maintenance costs are very low compared with those of other qualified plans. Some businesses may be eligible for a tax credit of up to $500 per year for each of the first three years for the cost of starting the plan.

SEP IRA contributions are discretionary, meaning that every year the employer can decide if it wants to fund the SEP for that year. This makes SEP IRAs particularly ideal for businesses that are cyclical in nature or during hard economic times. During the good years, a company can make larger contributions for its employees and reduce that amount when profits are not so good.