Summary of SEP IRA, contribution limits, and deadlines

A SEP is a simplified employee pension plan and is designed to furnish business owners with an easy way to make contributions toward their employees’ retirement and, if self-employed, their own retirement. Contributions are made directly to an Individual Retirement Account or Annuity (IRA) set up for each employee (a SEP IRA).  Contributions are tax deductible and investments grow tax deferred.  10% early withdrawal penalties exist if participants make withdrawals prior to turning 59 1/2 – much like other tax sheltered plans (401(k) and traditional IRA.)

[table id=4 /]

Follow this link for information on Traditional and Roth IRA contribution limits.

Details of SEP IRA, contributions limits, and deadlines

The SEP IRA was designed as a low cost solution for allowing small businesses to provide employees with a pension without shouldering the high administrative costs of 401k’s and defined benefit plans. When an employer contributes to a SEP IRA the money goes into an IRA owned and managed by the employee.

Know the difference between contributions and deductions.

• Contribution – The amount you pay into a plan for all those participating in the plan, including self-employed individuals. Limits apply to how much, under the contribution formula of the plan, can be contributed each year for a participant.
• Deduction – The plan contributions you can subtract from gross income on your federal income tax return. Limits apply to the amount deductible.

Which broker should you use to manage your SEP IRA?  Good question.  I highly recommend using a discount broker and of the firms I’ve worked with I like TradeKing the best.

SEP IRA contribution limits

For corporations:

One of the primary benefits of a SEP IRA is that it has a high contribution limit. The 2009, 2010, and 2011 contribution limits for eligible employees are the lesser of either $49,000 or 25% of total employee compensation.

• Example 1: Your employee earned $50,000 for 2010. The maximum allowable contribution to their SEP IRA is $12,500 (25% x $50,000.)
• Example 2: Your employee earned $200,000 for 2010.  The maximum allowable contribution to their SEP IRA is $49,000 (because 25% of $200k is $50k which exceeds the $49k limit.)

For sole proprietors:

Contribution limits for the self-employed are not quite as straight forward but, barring limits, are approximately 20% of net profits with a maximum of $49,000. Remember that any contributions to a 401(k) or IRA, along with any employer matches to your 401(k) contributions, reduce your $49,000 maximum. Basically… all combined investments in defined contribution plans cannot exceed $49,000.

• Example 1:  You earned $50,000 for 2010.  Your maximum allowable contribution to your SEP IRA is $10,000 (20% x $50,000.)
• Example 2:  You earned $250,000 for 2010.  Your maximum allowable contribution to your SEP IRA is $49,000 (because 20% of $250k is $50k which exceeds the $49k limit.)

Only income from the business can be contributed.  Put another way, you cannot contribute money from another job separate from your business. Also, an adjustment is necessary to account for their ability to deduct both FICA taxes paid, and contributions to their own SEP IRA, both of which count toward their maximum deductible income for the year.

SEP IRA contribution and deduction deadlines

The contribution deadline for previous year SEP IRA contributions is the same as the due date of your employer’s return, including extensions. That means it is not too late for those with small businesses to lower their taxable income by contributing to their SEP IRA.

Other SEP IRA details

As mentioned above, most of the same rules that govern a Traditional IRA also apply to a SEP IRA. Specifically the minimum, no-penalty withdrawal age of 59-1/2, and the required minimum distributions beginning at age 70 1/2. Since the money contributed to a SEP IRA is pre-tax, distributions will be taxed at whatever rates are in effect for your bracket during the year of distribution.  Unlike regular contributions to a traditional IRA, contributions under a SEP can be made to participants over age 70 1/2 . If you are self-employed, you can also make contributions under the SEP for yourself even if you are over 70 1/2.  Just remember that participants age 70 1/2 or over must take required minimum distributions. As a final consideration, the IRS does not allow a loan to be taken out against the remaining account balance. This common feature of 401k plans provides a semi-liquidity option many have come to expect, the absence of which should be considered before large sums are contributed.

Which broker should you use to manage your SEP IRA? Good question. I highly recommend using a discount broker and of the firms I’ve worked with I like TradeKing the best.

Note:  I am not a tax professional. Consult IRS Publication 560 and/or your tax professional for details.