SEP IRA

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A Simplified Employee Pension Individual Retirement Account is a variation of the Individual Retirement Account used in the United States. Even more so than the SIMPLE IRA, the SEP IRA really is "simple." There are no real administration costs if you are self-employed and don't have any employees. If you do have employees, all employees must receive the same benefits under a SEP plan. Since SEP accounts are treated as IRAs, funds can be invested the same way as any other IRA.

For a detailed reading on SEPs, see IRS Pub 560 at: http://www.irs.gov/pub/irs-pdf/p560.pdf

Deadline for Establishment and Contributions: Filing deadline for employer's tax return, including extensions.

The following employees who meet the following conditions:
1) be at least 21 years of age
2) has worked for the employer for at least three of the previous five years, and
3) received at least $450 in compensation for the tax year

must be eligible for the employer's SEP IRA plan.

SEP IRA funds are taxed at ordinary income tax rates when qualified withdrawals are taken after age 59.5 (the same rule as for traditional IRAs). Contributions to a SEP plan will lower a taxpayer's income tax liability in the current year.

SEP-IRA contributions are treated as part of a profit-sharing plan. For employees, the employer may contribute up to 25% of the employee's wages to the employee's SEP-IRA account. For example, if an employee earns $40,000 in wages, the employer could contribute up to $10,000 to the SEP-IRA account because 25% of $40,000 equals $10,000.

For self-employed persons, the effective maximum amount that may be set-aside from Schedule C earnings is slightly less than 20% of net earnings from self-employment. For example, if a sole proprietor has $50,000 net earnings from self-employment on Schedule C, then the "1/2 of self-employment tax credit" ($3,532), shown on adjustments to income at the bottom of form 1040, will be deducted from the net earnings and the result is multiplied by 20% to arrive at the maximum SEP deduction. ($9,293) The effective maximum rate of net earnings for self-employed individuals that can be contributed to SEP and deducted is approximately 18.6%. Note that net earnings INCLUDE the proposed deduction for contributions to your own SEP-IRA. In this example, the sole proprietor has therefore $59,293 in net income before his (maximum) SEP-IRA contribution.

The total contribution to a SEP-IRA account is the lesser of 25% of income (20% for self-employed before self-employed tax credit is included) or $42,000 for 2005; thereafter, the amount is indexed for inflation.