Under a SEP, you as the employee must set up an IRA to accept your employer's contributions.  As a general rule, your employer can contribute up to 25 percent of your pay into a SEP each year, up to a maximum of $40,000.

Starting January 1, 1997, employers may no longer set up Salary Reduction SEPs.  However, the Small Business Job Protection Act of 1996 (Public Law 104-188) permitted employers to establish SIMPLE IRA plans beginning in 1997.  A SIMPLE IRA plan allows salary reduction contributions up to $6,000 in 2001 ($7,000 in 2002).

If an employer had a salary reduction SEP in effect on December 31, 1996, the employer may continue to allow salary reduction contributions to the plan.  Employees are generally permitted to contribute up to 15 percent of pay, or $10,500 for 2001 ($11,000 for 2002).  SEP participants may also be required to earn at least $450 (this number is indexed for inflation) (for 2001) to make salary reduction contributions.

Q: What are 401(k) plans?

A 401(k) plan is a defined contribution plan that is a cash or deferred arrangement.  You can elect to defer receiving a portion of your salary which is instead contributed on your behalf, before taxes, to the 401(k) plan.  Sometimes the employer may match your contributions.  There are special rules governing the operation of a 401(k) plan.  For example, there is a dollar limit on the amount you may elect to defer each year.  The dollar limit is $11,000.  The amount may be adjusted annually by the Treasury Department to reflect changes in the cost of living.  Other limits may apply to the amount that may be contributed on your behalf.  For example, highly compensated employees may be limited depending on the extent to which rank and file employees participate in the plan.  Your employer must advise you of any limits that may apply to you.

Although a 401(k) plan is a retirement plan, you may be permitted access to funds in the plan before retirement.  For example, if you are an active employee, your plan may allow you to borrow from the plan.  Also, your plan may permit you to make a withdrawal on account of hardship, generally from the funds you contributed.  The sponsor may want to encourage participation in the plan, but it cannot make your elective deferrals a condition for the receipt of other benefits, except for matching contributions.