When an employee becomes vested in a retirement plan, it means that he or she has participated in a plan long enough or has provided enough years of service to an employer such that the employee becomes entitled not only to the contributions that the employee might have made (which is not applicable in a SEP) but also to the contributions made by the employer. In plans other than SEPs, if an employee is not vested in a plan, the employee is not entitled to the contributions made by the employer.
In traditional pension plans, employers generally set up a vesting schedule. For example, they might provide that an employee is 33 percent vested after three years, 66 percent after four years, and 100 percent after five years. SEPs are different. The employee's right to employer contributions in a SEP is always 100 percent vested. Therefore, your employee has the full ownership right to the contributions in the account at all times.
Even so, there are penalties for early withdrawals. Since SEPs are based on
IRAs, the IRA penalties apply. If an employee who has not reached age 59 1/2
makes an early withdrawal, the employee will have to pay a 10 percent penalty
tax. In addition to the 10 percent tax, the employee must include the
distribution in income for the year in which it was received. As with regular
IRAs, penalties can be avoided if the employee rolls the amount over into
another IRA within 60 days.