Simplified Employee Pension Plan (SEP-IRA)
Definition
A Simplified Employee Pension (SEP) IRA is a retirement savings plan established by employers, including self-employed individuals, for themselves and their employees. The SEP-IRA stands out for its simplicity and ease of administration compared to other retirement plans, making it an attractive option for small business owners and the self-employed.
Under a SEP-IRA, the business owner contributes directly to individual retirement accounts (IRAs) set up for each eligible employee, including themselves. These contributions are tax-deductible for the employer, and the income earned within the account is tax-deferred until withdrawal.
Key Features
- Eligibility: Available to sole proprietors, partners in a partnership, owners of businesses (both incorporated and unincorporated), including S corporations, and self-employed individuals.
- Contribution Limits: Employers can contribute up to 25% of each eligible employee’s compensation, limited to $49,000 for the year 2010 (adjusted annually for inflation).
- Tax Treatment: Contributions are tax-deductible, and investment earnings grow tax-deferred until withdrawal.
- Account Ownership: Each employee sets up a separate SEP-IRA account to receive contributions.
Examples
- Self-Employed Consultant: A freelance consultant sets up a SEP-IRA to save for retirement, contributing 25% of their annual earnings into the account.
- Small Business Owner: The owner of a small bakery with five employees establishes SEP-IRA accounts for herself and each eligible employee, contributing a percentage of their respective annual salaries to the SEP-IRAs.
Frequently Asked Questions (FAQs)
Q1. Who is eligible to contribute to a SEP-IRA? A1. Self-employed individuals, sole proprietors, partnerships, S corporations, and other small business owners can establish SEP-IRAs for themselves and their eligible employees.
Q2. How much can an employer contribute to a SEP-IRA? A2. Employers can contribute up to 25% of each eligible employee’s compensation, with annual limits subject to adjustment (e.g., $49,000 for 2010).
Q3. Are contributions to a SEP-IRA tax-deductible? A3. Yes, employer contributions to SEP-IRAs are tax-deductible, and the income earned within the accounts grows tax-deferred until withdrawals are made.
Q4. When can SEP-IRA funds be withdrawn without penalty? A4. Funds can be withdrawn without penalty starting at age 59½, though taxes will be owed on the amounts withdrawn.
Q5. Can an employee contribute to their SEP-IRA? A5. No, only the employer contributes to a SEP-IRA. However, employees may have other individual retirement savings accounts where they make their own contributions.
Related Terms
- Traditional IRA: An individual retirement account in which contributions may be tax-deductible and investment earnings grow tax-deferred until withdrawal.
- Roth IRA: An individual retirement account where contributions are made with after-tax dollars, but withdrawals, including earnings, are tax-free in retirement.
- 401(k) Plan: A retirement savings plan sponsored by an employer allowing employees to save and invest a portion of their paycheck before taxes are taken out.
Online Resources
- IRS: Simplified Employee Pension Plan (SEP)
- Investopedia: SEP IRA
- U.S. Department of Labor: Simplified Employee Pension Plan (SEP)
Suggested Books for Further Studies
- The Bogleheads’ Guide to Retirement Planning by Taylor Larimore, Mel Lindauer, Richard A. Ferri, and Laura F. Dogu.
- Retire Secure!: A Guide to Getting the Most Out of What You’ve Got, Third Edition by James Lange.
- The Smartest Retirement Book You’ll Ever Read by Daniel R. Solin.
Fundamentals of SEP-IRA: Retirement Planning Basics Quiz
Thank you for exploring the SEP-IRA retirement plan with this comprehensive guide and challenging quiz questions. Continue your journey towards financial security!
