A Simplified Employee Pension, or SEP, is an ideal retirement plan for a sole proprietor. It offers all the benefits of a traditional individual retirement plan or IRA and a company-sponsored retirement program. A sole proprietor can contribute to a SEP IRA as both an employer and an employee. SEP plans are easy to set up and require little paperwork to maintain.

SEP Setup

An SEP is established with a formal written agreement, typically using Internal Revenue Service Form 5305-SEP, and opening an IRA for each employee to which the employer will contribute. This agreement has to be filed by April 15 for the prior tax year, but sole proprietors can get an extension until October 15.

Contribution Limits

Sole proprietors with employees contribute at least 1 percent of an employee's total compensation and up to 3 percent on a dollar-for-dollar matching basis. The amount can vary from year to year but must be the same for all employees, with a limit of $50,000 for the 2012 tax year and $51,000 for 2013. Percentages are based on total compensation up to $250,000 for 2012 or $255,000 in 2013.

Additional IRA Contributions

An employee with a sole proprietor SEP can use that account for traditional IRA contributions or make contributions to a separate traditional IRA. IRS Publication 560 says employer contributions to a SEP will not affect the amount an individual can contribute to a traditional IRA, $5,000 a year or $6,000 for those over age 50. However, tax deductions for those contributions could be limited. In some cases non-deductible contributions can be made to a traditional IRA.

Self-Employed Limits

A sole proprietor with no employees or a self-employed individual is limited to contributing 20 percent of adjusted earned income, based on an IRS worksheet, to a SEP. Basically that is net income on a Schedule C, profit and loss from business, minus half the self-employment tax figured on a Schedule SE. Contributions are subject to the same income limits.