Designed to be a tax-deferred retirement plan for small businesses, solo proprietors, and other self-employed individuals, the sep ira is beneficial for gross income limits exceeding the maximums for other ira accounts. Learn what is a sep ira contribution, distribution, and eligibility requirement and how it compares to other ira’s below.
Qualifications
This account is open to S and C corporations, Limited Liability corporations, solo proprietorships, and non-profits, so long as there is one or more employed persons. This means a self-employed business owner can be considered the employee for purposes of eligibility. Employees may participate in an employer-sponsored sep ira, but may not open one on their own.
To set up the sep for employees to participate in, the business owner has a formal agreement drafted of intent to provide benefits to eligible employees. Eligibility requirements include:
-at least age 21
-has earned a minimum of $500 in the previous year
The employer can also use ready forms available on the IRS website, and may need to take additional steps if they are contributing to another qualified retirement arrangement.
Contributions
Larger contribution limits are a benefit of this retirement arrangement, but can be complicated to calculate. For 2010, the limit is set at $49,000 per year and money is tax-deferred until withdrawal. As with traditional ira’s, the minimum allowed age for taking distributions is 59 ½; early withdrawals face a 10 % penalty.
For self-employed individuals, the limits are different. The law says up to 20% of net income less the adjustment for self-employment tax, or about 18.5% may be contributed. There may be other considerations, and the services of a financial or tax planner are recommended.
A benefit of the contribution structure is the discretionary payments. Employers can decide on a year to year basis if they wish to make a deposit to fund the account. This is useful when business is slow or capital is being allocated elsewhere.
Distributions
The traditional ira rules also apply for sep retirement arrangements. This means the account owner must be at least age 59 ½ before they may take money out without penalty. Taken out before this age, the money is taxed as earned income and levied a 10% penalty. More importantly, the money must begin distributing to the owner by the age of 70 ½ or face a penalty of 50% of the gross distribution payment. All distributed income is taxed at the applicable rate.
There are exceptional circumstances under which the IRS does not charge a penalty, as with a traditional or Roth arrangement. If one becomes disabled, takes money out for medical expenses the insurance company does not cover, or uses funds to pay for higher education expenses, for instance, they are not penalized.
Conclusion
Set up and contributions must be filed by the regular tax deadline of April 15 to establish the fund for the prior year. As with any retirement plan, the sooner it is begun the more money it will accumulate. Set up the plan with a competent financial adviser or accountant to ensure all deadlines are met, and all paperwork is accurate.
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