The SEP IRA - Simplified Employee Plan
The Simplified Employee Pension Plan (SEP) enables business owners to make IRA contributions of up to $44,000 in 2007 (increasing to $45,000 in 2008 and then subject to annual cost-of-living adjustments for later years) toward their own and their employees' retirement, without getting involved or setting up a more complex qualified arrangement, such as a Code Section 401 (k) plan.
With a SEP, contributions are made to an Equity Trust IRA set up by, or for, each eligible employee. SEP IRAs are owned and controlled by the employee. The employer makes contributions to his own SEP IRA, as well as the SEP IRA of any employees, and must contribute the same percentage for all eligible employees.
- Business Eligibility - Any employer, whether a corporation, partnership, or self-employed individual, may establish the plan, even if there is only one employee.
- Employee Eligibility - Employees must be at least 21 years of age, have worked for the business during any three of the past five years, and earned the annual minimum required compensation of $500 in 2007.
- Spousal Eligibility - Your spouse and children may also participate in the plan and open their own SEP IRAs - as long as they are employees of the company and meet the income requirements.
- Employer Contribution - An employer may contribute up to 25% of each eligible employee's annual compensation up to a maximum of $44,000 in 2007 (increasing to $45,000 in 2008 and then subject to annual cost-of-living adjustments for later years). In making any employer contributions, for 2007 only compensation up to $220,000 can be considered (increasing to $225,000 in 2008). The employer is allowed to make contributions annually, but is not required to make any contribution for any particular year.
- Deductions - Employers may deduct every qualified dollar they contribute from their taxable income.
Please note that annual compensation refers to salary/wages for employees or earned income for those self-employed. If you receive only rental income (passive income), you will need to pay yourself a salary (earned income) to be eligible for an IRA.
As with Traditional and Roth IRAs, clients can use funds from their SEP IRA to invest in any of the different investment vehicles offered at Equity Trust Co. (see Self-Directed IRA Investment Opportunities at Equity Trust).
Below, we provide answers to some of the commonly asked questions about the SEP IRA. You may also want to refer to the self-directed IRA SEP vs. self-directed SIMPLE IRA comparison and use the Equity Trust small business retirement plan calculator. For more details about the SEP IRA, please refer to IRS Publication 560.
- Who can establish a SEP IRA?
- What are the eligibility requirements for employees?
- How much can be contributed to a SEP IRA?
- Are SEP IRA contributions tax-deductible?
- Are SEP IRA investments tax-deferred?
- Can a SEP IRA owner have a regular IRA as well?
- Can a SEP IRA be converted into another type of IRA, such as a Roth?
- What are the rules for distributions or withdrawals, rollovers or transfers?
- Must employers make contributions for each employee?
- What if I am a self-employed individual with no employees?
- Must employers contribute the same percentage each year?
- What is the deadline for establishing and contributing to a SEP IRA?
- Can you give an example of how a SEP IRA could help me?
- How do I open a SEP IRA at Equity Trust?
- How do I transfer funds from another IRA, Qualified Plan or Tax-Sheltered Annuity to Equity Trust?
Who can establish a SEP IRA?
Any employer, whether a corporation, partnership or sole proprietorship can establish a SEP IRA. Self-employed income can be earned by providing a service (either full-time or part-time), so, if you are a self-employed individual, you can establish a SEP even if you are covered by a retirement plan at a separate job with an unrelated employer.
What are the eligibility requirements for employees?
An employee is eligible if he/she has reached the age of twenty-one, has worked for you in at least 3 of the last 5 years, and has at least $500 in compensation from you in the previous full year of employment.
How much can be contributed to a SEP IRA?
A SEP IRA owner may contribute up to 25% of an employee's compensation up to the annual compensation cap. The annual compensation cap in 2007 is $220,000 and $225,000 for 2008 and then subject to annual cost-of-living adjustments for later years. The maximum dollar amount that may be contributed in 2007 is $44,000 ($45,000 in 2008 and then subject to annual cost-of-living adjustments for later years).
Are SEP IRA contributions tax-deductible?
Yes! Every dollar that is contributed to a SEP IRA for yourself and your employee (within the above limits) qualifies as a deduction.
Are SEP IRA investments tax-deferred?
Yes! All investment earnings are tax-deferred until they are withdrawn.
Can a SEP IRA owner have a regular IRA as well?
Yes! In addition to your SEP IRA you can have a regular IRA.
Can a SEP IRA be converted into another type of IRA, such as a Roth?
Yes. You can convert SEP IRA funds at any time.
What are the rules for distributions or withdrawals, rollovers or transfers?
A SEP IRA must permit employees to withdraw contributions at any time (subject to the tax rules generally applicable to IRA Distributions). Thus, distributions that occur before the employee reaches the age of 59 1/2 are subjected to a 10% early-withdrawal penalty, in addition to any income tax, unless the distribution is made as a result of one of the following events:
- death;
- disability;
- education expenses;
- unreimbursed medical expenses that exceed 7.5% of your adjusted gross income;
- medical insurance premiums;
- expenses associated with buying or building first home; and
- payment of an IRS levy.
For additional information regarding the IRA rules, including the tax treatment of distribution, rollovers, RMDs and any applicable income tax withholdings, please see IRS Publication 590.
Must employers make contributions for each employee?
Yes. Under a SEP, you must contribute a uniform percentage of compensation for each employee who satisfies the eligibility requirements described above (See What are the eligibility requirements for employees?). However, this rule is not violated if the contribution allocation formula permits employees with compensation above a specified level to receive an extra portion of the contribution within permissible limits. This is known as "permitted disparity" and takes into account that employees with compensation above the social security wage base are receiving a smaller percentage of their pay being funded by their employer through the social security system.
For example, if in 2007, Employee A makes $30,000, Employee B makes $95,000 and Employee C makes $225,000 and the Social Security Wage base is $97,500, the Employer could make the following allocations to each of the employees under the "permitted disparity" rule without violating the SEP contribution requirements:
Employee & Contribution % Actual Contribution
Employee A: $30,000
(Contribution of 16.77% of compensation) = $5,031
Employee B: $95,000
(Contribution of 16.77% of compensation = $15,931
Employee C: $225,000
(Contribution of 20% of compensation = $45,000
What if I am a self-employed individual with no employees?
If you have no employees, that is not a problem; all you need to do is sign up and start to contribute. All the tax advantages mentioned above are available to you as a self-employed individual.
Must employers contribute the same percentage each year?
No. You may vary your contribution percentage any time prior to the last permissible contribution day. In addition to varying contributions, you can elect to skip them for any year.
What is the deadline for establishing and contributing to a SEP IRA?
The deadline for both establishing and contributing is the tax-filing deadline for the company. April 15 is the deadline for most self-employed individuals.
Can you give an example of how a SEP IRA could help me?
In 2006, Mrs. Jones owns her own mortgage company and earns $100,000 per year in W-2 income. She is the only eligible employee. While she agrees with Mr. and Mrs. Smith that she is paying excessive amounts in tax each year, and has heard from the Smiths how good a SIMPLE plan at Equity Trust is, she realizes that the SEP plan would be even better for her.
As the employer, Mrs. Jones chooses to contribute 15% of her salary to her SEP. Along with her $4,000 contributed to her Equity Trust Roth IRA, she is now able to contribute $19,000 to her IRAs and reduce her company's taxable income by $15,000!
As with the SIMPLE plan, it should be noted that if Mrs. Jones has a husband and children, they may also participate in the SEP plan and enjoy all the benefits she will - as long as they are employees of the company.
Once the plans have been established, a SEP and SIMPLE IRA follow the same guidelines as a Roth IRA or Traditional IRA. The only exception is that a SIMPLE IRA must stay as a SIMPLE for two years before it can be converted to a Roth IRA.
At Equity Trust, clients have the option of using funds from their SEP, SIMPLE or Individual(k) Plan to invest in all forms of real estate, as well as any other IRS-permitted investments. All of these small business retirement plans allow investors to enjoy the benefits of tax-deferred, compounded growth while choosing real estate or other alternative investments in which they have knowledge and expertise.
How do I open a SEP IRA at Equity Trust?
Instructions on how to open a self-directed SEP IRA at Equity Trust.
How do I transfer funds from another IRA, Qualified Plan or Tax-Sheltered Annuity to Equity Trust?
Instructions on how to transfer and rollover IRAs into an Equity Trust IRA.