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Retirement: For Businesses: SEP IRA

Overview

A Simplified Employee Pension (SEP) IRA is a retirement plan for small businesses and self-employed individuals that allows employers to make discretionary contributions for themselves and their employees. Contributions may be federally tax-deductible to the employer and are generally not taxable to the participants until withdrawn.

Eligibility

Just about any business can establish a SEP Plan. This includes:

  • Sole proprietors
  • Partnerships
  • S corporations
  • C corporations
  • Nonprofit organizations

Contribution Limits

For the 2013 tax year, the maximum contribution is 25% of eligible employee compensation up to a maximum of $51,000.

For the self-employed, a special calculation is required taking into consideration the following two deductions:

  • The deduction of one-half of self-employment tax.
  • The deduction for contributions to your own SEP IRA.

Catch-Up Contributions

Because there are generally no salary deferrals in a SEP IRA, there are no provisions allowing catch-up contributions.

Distributions

Distributions from a SEP IRA generally are includible as income for the year received. Withdrawals prior to age 59½ may be subject to a 10% additional tax.

Deadlines

The deadline to establish a SEP IRA is the employer's tax filing deadline, including extensions.
The deadline to fund a SEP IRA is also the employer's tax filing deadline, including extensions.

How to Establish a SEP IRA with Principal Funds

  1. Request the paperwork to establish a SEP IRA from your financial professional or Principal Funds.
  2. The employer must complete the adoption agreement.
  3. All eligible employees should be notified of the plan.
  4. Each employee should complete a Principal Funds SEP IRA application.
  5. The adoption agreement and all applications should be returned to your financial professional.

Frequently Asked Questions

Do employees have to be included in the plan?
Any employee who meets the eligibility requirements must be included in the plan.

Does a contribution have to be made each year to the SEP?
No, contributions do not have to be made each year. If the business has a bad year, the employer is not obligated to contribute at all. But it's all or nothing. If the owner chooses not to contribute to the employees' accounts, no contribution may be made to the owner's account either.

Employees may not make SEP IRA contributions. But they may make regular contributions to a traditional or Roth IRA.

Can a participant contribute to their own traditional IRA if they have a SEP?

Yes, an individual may still contribute the lesser of the applicable limit or 100% of compensation to an IRA. However, as a participant in the SEP, the individual would be considered covered by an employer-sponsored plan. This means that the deductibility of the IRA contribution may be limited.

What is a SAR SEP?
A SAR SEP is a SEP plan that allowed salary deferral contributions. Because of its complex nature, the IRS ceased allowing them to be established after 12/31/1996 and created the SIMPLE IRA to replace it. SAR SEPs that were established prior to 12/31/1996 were allowed to continue and many are still in existence.

I have a client who is a sole proprietor, has no employees, and makes $60,000 a year. Is a SEP the right plan?
There are a number of variables. See table below:

 

SEP IRA

SIMPLE IRA

Solo 401(k)

Deadline to set up

Tax filing deadline, plus extensions

October 1

December 31

Multiple employees allowed?

Yes

Yes

No

Maximum contribution

Employee: $0
Employer: 25%1 x $60,000 = $15,000
TOTAL: $15,000

Employee: $12,000
Employer: 3% x $60,000 = $1,800
TOTAL: $13,800

Employee: $17,500
Employer: 25% x $60,000 = $15,000
TOTAL: $32,500

Administration and expense

Administration is simple and cost is low. Funding cost depends on number of employees and level of contributions.

Administration is simple and cost is low. Funding cost depends on number of employees and level of contributions.

Funding cost depends on employer options; generally more expensive than SEPs and SIMPLEs.

1 If you contribute to your own SEP IRA, you must make a special computation to figure your maximum deduction for these contributions. Generally, the computation must take into account the deduction for one-half of your self-employment tax as well as the deduction for your own contributions. See IRS Publication 560 for more information.

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