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The SEP IRA Explained

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One of the more unique types of retirement accounts is the Simplified Employee Pension IRA, or SEP IRA for short.  This plan is designed for self-employed folks, as well as for small businesses of all tax organization, whether a corporation (S corp or C corp), sole proprietorship, LLC, LLP, or partnership.

The primary benefit of this plan is that it’s simplified (as the name implies) and very little expense or paperwork is involved in the setup and administration of the plan.  The SEP becomes less beneficial when more employees are added, and there are some additional options available in other plans (such as a 401(k)) that may be more desirable to the business owner.

SEP IRAs have a completely different set of contribution limits from the other kinds of IRAs and retirement plans.  For example, in 2012, you can contribute up to $50,000 to a SEP IRA. That amount is limited to 20% of the net self-employment income, or 25% of wage income if the individual is an employee of the business.

The account for each participant is an IRA, just like any other IRA (other than the contribution limits mentioned above).  You’re allowed to invest in any valid investment security, rollover the plan (upon termination of employment) and direct the plan to your heirs however you wish.

Money contributed to the plan is not taxed to the employee/participant upon contribution, and any growth in the account is tax-deferred until distribution.  At the distribution of the funds, the money will be taxed as ordinary income.  Upon reaching age 59½ you can access the funds without penalty – otherwise, unless you meet one of the early distribution exceptions, there is a 10% penalty imposed in addition to the income tax on the distribution.  At age 70½ you will be required to begin taking minimum distributions from the account, just like any other IRA.

Additionally, a SEP IRA can be established up to the filing date for your business entity – as late as April 15 of the following year if you like.  This is different from a 401(k), for example, which must be established during the tax year.

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  2. AnneNo Gravatar says:

    Thanks Jim: I will copy this article for my files concerning my HerbaLife Business!

    Comment: Playing one’s financial cards correctly is very important; I notice Uncle Sam has programs which help a citizen to be employed and retain SSA funds and or reduce taxes; I learn much of this from reading your blogs; thanks alot !

    Anne Conn. USA