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LegalCornerTM - Retirement Accounts F.A.Q.'s

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Q.What is a SEP-IRA?

A.A SEP IRA (Simplified Employee Pension) is a simple retirement plan that functions like a traditional IRA, but allows the self-employed individual to contribute (for 2008) the lesser of: (1) 20% of the net profit from the business less one-half of the self-employment tax paid (or 25% of his or her salary) or (2) $46,000.

The SEP is an employer-contribution-only plan. Even if the business is a sole proprietorship (a one man or woman band), it is the business that is making the contribution to the plan, not the individual. Consequently, contributions to a SEP IRA are 100% tax deductible. Any investment earnings in a SEP IRA grow taxed free. Withdrawals from a SEP-IRA after age 59 1/2 are taxed as ordinary income.

A SEP IRA plan can be established by a one person business or by a business owner with multiple employees. In either case, the SEP IRA must be funded 100% by the employer. Employees cannot contribute to a SEP.

When a SEP IRA is established by a business with multiple employees, the owner of business and each eligible employee must open their own separate SEP IRA account. Annually the employer will make a contribution to their own personal SEP IRA account and to each eligible employee's SEP IRA account. The percentage contributed must be the same for the employer and each eligible employee.

When a SEP IRA Plan is established by a sole proprietor (a one person business), the owner has the flexibility each year to choose whether or not to make a contribution, and if so, in what amount, all of which can be based on the performance of the business. Sole proprietors have until April 15, or to their extension deadline, to make a SEP-IRA contribution for a tax deduction for the prior tax year.

Creating a SEP-IRA is simple. The owner / employer must complete IRS Form 5305-SEP, and the owner / employee must complete an IRA investment application supplied by a financial institution which will hold the SEP-IRA funds.

For more information, visit the IRS’s Retirement Plan Community on SEP-IRAs.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained on this web site is not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed on a taxpayer under the U.S. Internal Revenue Service.

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