SEP IRA Eligibility: Who Can Contribute & Qualify?

SEP IRA rules allow for any company that is incorporated or unincorporated with one or more full-time employees to set up a qualified retirement plan. The employer is the sole contributor to the plan, and the employer may be a sole proprietor, partnership, LLC, Subchapter S or C corporation. This opens up the SEP plan to a wide array of companies as long as an eligible employee is present.

Employee Eligibility

All eligible employees must be at least 21 years old, have three years of service in the past five years and have earned at least $450 in compensation from the employer. In general, these rules are in place to exclude one-time independent contractors or temporary employees from receiving benefits in the plan. However, part-time employees are eligible as long as they meet the $450 minimum and have worked at least 3 years in the past 5 years. To determine employee eligibility, an employer fills out an IRS Form 5305.

Spousal and Family Eligibility

The SEP IRA program can benefit companies employing family members. The employer must immediately vest the same percentage of income as he or she is receiving as the business owner into an IRA account for all participants, including family members. Since the rules are extremely equal, there is no favoritism for family members employed in the company. This can be expensive for an employer since the employer is the only contributor. When the recipient of the funds is a spouse or child, however, the tax deductible expense may be easier to stomach.

Benefits of SEP IRA Rules

The SEP IRA is most beneficial to an individual with a very small business since it is costly per employee. The business owner should have a desire to contribute to his or her own IRA as well as those of his or her partners and direct employees. Since the owner must contribute the same amount to his or her account as to the employees’ accounts, it is important the employer is prepared to take on this expense. For this reason, the SEP IRA is popular in partnerships, family-owned businesses and sole proprietorships. The low level of forms required makes the plan cheap to administer even if it requires high annual contributions from the employer.

Downsides of SEP IRA Rules

The main drawback of the SEP IRA is the fact that an employer must compensate all employees equally. If one employee is outperforming another or has been more loyal to the company, no additional IRA funds can be contributed on that employee’s behalf. This removes the ability for an employer to offer retirement funds as an incentive for employee performance or loyalty. Further, the SEP IRA is not a good option for a growing business. The unique circumstances provided by an SEP IRA are truly best for a very small operation, and the business will quickly incur too much expense if it continues to grow beyond a low number of current employees.

Will a new employee be eligible for an SEP IRA?

A new employee will not immediately be eligible for an SEP IRA. SEP IRA requirements clearly state that an employee must have at least three years of service to the organization in the past five years. In addition, the employee must earn at least $450 from the employer in the given year to be eligible. These restrictions make it impossible to extend an SEP IRA immediately to a new hire. However, the individual may set up his or her own IRA account and roll the plan over into the company's IRA plan in the future.

Can I open an SEP IRA for myself if I am the only employee of my business?

If you run a sole proprietorship, you are eligible to open an SEP IRA. In fact, the SEP IRA plan is most beneficial for extremely small businesses. Under this plan, the owner of the business must contribute the same amount to an employee's IRA plan as he or she does to the owner's account. This means all employees, regardless of level of management or time with the company, will receive the same contribution amount annually. This makes the SEP IRA most feasible for a single-employee company or a partnership. Individuals who employ family members may also favor this plan.