A SEP-IRA (Simplified Employee Pension) allows employers to make retirement plan contributions to its employees. In addition, self-employed individuals may create and fund a SEP-IRA retirement plan for themselves. Compared to the better-known 401(k) plan, potentially higher contribution limits along with far less complexity are key SEP-IRA benefits.
Who Can Set Up a SEP-IRA?
Any employer can establish a SEP-IRA, including sole proprietorships, partnerships, and unincorporated business. An individual with earnings from self-employment may create a SEP-IRA, even if he is also an employee elsewhere covered by a workplace retirement plan.
Benefits of a SEP-IRA
In addition to the SEP-IRAs primary benefit as an easy-to-implement retirement savings vehicle, a SEP-IRA can also provide large tax benefits. Contributions to a SEP-IRA provide a tax deduction to the employer (or self-employed individual) for the tax year to which the contributions are designated.
SEP-IRAs lack an annual IRS filing requirement. As further evidence of their simplicity, the paperwork necessary to establish a SEP-IRA is minimal.
Important SEP-IRA Dates
Like regular IRAs and Roth IRAs, contributions to a SEP-IRA can be made following the year to which the contribution applies. In addition, the ordinary SEP-IRA contribution deadline can be extended to as late as the extended due date of the tax return.
The deadline for creating the SEP-IRA is also the due date of the tax return plus any extensions. For most people, the SEP-IRA must be established and the contributions made by the April 15 following the year the income was earned. Furthermore, most taxpayers may extend their tax returns to as late as October 15 and thereby also receive an extension of time to create and fund their SEP-IRAs.
SEP-IRA Contribution Rules
There is a great deal of flexibility in the amount you contribute to your SEP-IRA. There is very little flexibility in who you contribute it to.
Since the contribution amount can be determined annually, there is no obligation for an annual contribution of a certain amount or percentage. In any year, the contribution amount can be as little as 0% to as much as 25% of compensation, provided that the total contribution to any one individual does not exceed $46,000 for 2008 ($49,000 for 2009).
Note: The employer must contribute the same contribution percentage to every employee who is at least 21 years old, earned $500 or more for the year in question, and worked for the employer at least three of the previous five years.
Self-employed individuals who wish to calculate and possibly fund the maximum allowable SEP-IRA contribution should prepare for some head-scratching. First, the previously mentioned 25% limit is on net profit, not gross revenue. More importantly, the deduction for half of the self-employment tax as well as the deduction for the SEP-IRA contribution itself must be subtracted from the net profit number for purposes of calculating the SEP-IRA limit.