A SEP is like a profit-sharing plan that uses some Traditional IRA rules. A SEP IRA is a benefit for employees that uses employer contributions to fund retirement investment accounts for each employee.
Contributions are made on a pre-tax basis, the account grows tax-deferred, and the withdrawals are taxed as income. The employer contributions are immediately vested to the employees, who can exercise discretion with investment choices and allocations, among the investment options available in the plan.
SEP stands for Simplified Employee Pension, but it is a defined contribution plan instead of a defined benefit plan, as with most pensions. Part of the reason for this is that being defined-contribution eliminates much of the auditing and oversight requirements of defined benefit plans.
They are basically treated as safe harbor profit-sharing plan, but, unlike other profit-sharing plans, the employer is not at liberty to discriminate between employee groups: everyone must receive the same percentage of their compensation as an employer contribution in years where contributions are made.
Small businesses can appreciate the simplicity, ease of administration, and low cost to maintain such a plan. There are no limits on the number of employees that can be part of SEP arrangement, and they can be utilized by self-employed sole proprietors. They work especially well in a small company with a few high earners who want to defer taxes on as much of their compensation as possible.