SEP IRA Tax
A Simplified Employee Pension plan, commonly known as a SEP, is a retirement plan established by employers and the self-employed individual that is also suitable for sole proprietorships, S and C corporations, LLCs, and partnerships. The SEP IRA tax rules mimic those of a traditional IRA. Are there solid tax benefits to a SEP retirement plan? Contributions made to the SEP are tax-deductible and will lower the taxpayer’s income tax liability for the year in which they are made. The plan’s earnings are not taxed until they are distributed, and the funds are also taxed at ordinary income tax rates when qualified withdrawals are made. Distribution of the funds can start as early as when the account owner is 59 ½ years old, however there is a 10% penalty for earlier withdrawals, which is levied along with the normal income tax obligation. Similar to a traditional IRA, disbursements from the account must begin no later than age 70 ½. These SEP IRA tax rules allow participants to grow retirement savings in a tax-advantaged atmosphere, and defer tax payments until withdrawal of the funds. Because the funding vehicle for a SEP is a traditional IRA, the SEP contributions, once deposited, become traditional IRA assets and are subject to many of the same rules as a traditional IRA including allowable investments and distribution regulations. The employer may qualify for a tax credit of up to $500 per year for the first three years of the plan to cover the cost of establishing the SEP, and employer contributions are deductible from income in the year they are paid, or for the previous year until the tax-filing deadline. All of the money contributed to the account is fully vested, so the SEP account is immediately portable and can be rolled into another type of individual retirement account, or in the case of a job change can be transferred to a new employer’s sponsored retirement plan. SEP IRA tax rules mimic the regulations for a traditional IRA. The plans differ when it comes to contribution limits allowed, with the SEP offering much higher contributions. Eligible employees can contribute up to 25% of their annual compensation, although the employer is the one to determine contribution amounts and frequency, and can alter or suspend those contributions. The more generous contribution limit is an opportunity for employees to accumulate more retirement savings at a quicker pace, especially beneficial to those that may have gotten a late start saving and preparing for their retirement years. Employer contributions for each eligible employee will be the same percentage of compensation for all employees. All eligible employees are allowed to participate in the plan. An eligible employee is one who is at least 21 years old, has performed service for the company in at least three of the last five years, and has received at least $550 in compensation from the company during the year. The SEP IRA tax rule allows tax-deferred contributions and tax-advantaged earnings.