• SEP-IRAs help individuals build income tax-free.investing plans image by Mats Tooming from Fotolia.com
  
  Funded by employer contributions, a simplified employee pension plan, or SEP, provides an easy way for employers to contribute to employee pension plans or for a self-employed individual to contribute to her own pension plan. SEP contributions going into an individual retirement account, or IRA, make it a SEP-IRA.
  
  

Employer Limits

• According to the Internal Revenue Service, annual employer contributions to a SEP-IRA for the 2009 and 2010 tax years cannot exceed 25 percent of compensation or $49,000. Compensation calculations include bonuses and overtime, but generally do not include contributions made to the SEP itself. So, if John Doe earned $20,000 salary in 2009, including bonuses and overtime, the employer can make a maximum contribution to his SEP-IRA of $5,000, or 25 percent of $20,000.
  
  Except in special cases as determined by the employer's SEP plan rules, contributions are made proportional to the employee's annual income. In 2009 and 2010, contribution calculations can consider up to $245,000 of an employee's income. This amount, adjusted annually for cost-of-living, may change in 2011.
  
  

Self-Employed Limits

• Self-employed contributions match those explained above: 25 percent of compensation or $49,000 for 2009 and 2010. However, the IRS applies special rules when figuring out the maximum deductible contribution for a self-employed individual. For self-employed people making contributions to themselves, the IRS defines compensation as the net earnings from self-employment. This takes into consideration the deduction for one-half of his self-employment tax and the deduction for contributions made to the SEP plan. Calculating net earnings using this compensation definition helps a self-employed worker arrive at the allowable deduction for her personal contributions. The IRS provides worksheets and rate tables to simplify this complex calculation.
  
  

Additional Limitations

• SEP contributions occur at the employer's discretion and needn't occur annually. However, if an employer makes a contribution, all eligible employees must share in the contribution. Additional contribution limitations apply if an employer also contributes to another defined contribution plan on behalf of employees in addition to a SEP, such as a 401k. Then, employers may only contribute the lesser of two amounts: $49,000 or 100 percent of an employee's compensation. Eligible employees over age 70.5 years also may receive or make SEP contributions, although they must continue to take minimum distributions as required by law, according to the IRS.