SEP IRA Definition and Rules

Who’s Eligible?

To be eligible to open a SEP-IRA, you must be a sole proprietor, a business owner in a partnership, or earn self-employment income. If you have a regular 401(k) for your 9-to-5 job, but earn self-employment income from your novelty tea cozy business, you can set up a SEP-IRA with the profits from your sales.

SEP-IRA Contribution Rules and Limits

You can contribute up to 25% of an employee’s compensation into a SEP-IRA, or $53,000 for 2015, whichever is the lesser number. The SEP IRA contribution limits change yearly based on IRS cost-of-living adjustments.

If you’re self-employed, the same SEP-IRA maximum contribution limit applies to you, but you can’t deduct the contributions in the same way. The SEP-IRA contribution dead line is the same as the tax deadline for your business. That's April 15th, or later if you file an extension.

Withdrawal Limits

When you reach 70 ½ you’re required to start taking Required Minimum Distributions (RMDs) from your SEP plan if you have one. But if you withdraw money from the account before age 59 ½ you’ll face a 10% early withdrawal penalty, unless you qualify for an exception to this IRS rule. The money you withdraw from your SEP-IRA will be subject to standard income taxes. Sound familiar? That’s because the withdrawal rules for a SEP-IRA are like the ones for a traditional IRA.

Why a SEP-IRA?

          For a few reasons:

  • Contributions to a SEP-IRA are tax-deductible as business expenses, and the business pays no taxes on the investments’ earnings. Not too bad, right?
  • An employer is not required to make contributions each year. A business owner may decide on an annual basis whether to contribute to the employees’ SEP-IRAs, as well as how much to contribute. That means you can do what makes sense for your business on a yearly basis, and
  • you’re not locked into paying whatever amount you paid the year before.
  • Sole proprietors, partnerships and corporations, including S corporations, can set up SEP plans. It’s flexible.
  • Administrative costs for SEP-IRAs are relatively low compared to other retirement plans. And once it’s in place, a SEP is pretty simple to operate. A trustee will manage the deposits of contributions into employees’ accounts, as well as handle the investments and the preparation of any statements required by the IRS.
  • Your employees can still contribute to other retirement accounts. The amount you contribute to employees’ SEP-IRA plans won’t affect employees’ ability to contribute to another IRA.
  • SEP-IRAs have higher contribution limits than traditional or Roth IRAs.

Can I contribute a higher percentage for myself and my favorite employee?

Nope. Whatever percentage of compensation you decide to contribute to your own SEP account, you must contribute the same percentage for all of your employees.