Either write something worth reading or do something worth writing. - Benjamin Franklin
What it is:
SEP IRA stands for Simplified Employee Pension Individual Retirement Account. The SEP was designed for small business owners to provide a retirement benefit for themselves and their employees. Similar to a traditional IRA, contributions are tax-deferred. Moreover, required minimum disbursements are made when the account holder turns 70 ½2.
Unlike a traditional IRA, the contribution limits may exceed those of a traditional IRA. The administrative cost for employers with no employees are low.
How it works:
The SEP IRA is set up and funded exclusively by an employer. The employer receives a tax deduction for the contributions and the employees are not taxed until they withdraw from the account at their income tax rate. The deferred taxes reduce the employees’ taxable income for that year by the lesser of 25% of the employee’s income or $54,0001. SEP IRA’s also reduce tax liability because securities that are sold don’t trigger capital-gains taxes in the year of their sale. The employer is required to contribute at the same rate for all their eligible employees, but this rate can change from year to year. The SEP contributions are deposited into the employees traditional IRA accounts or special SEP-labeled IRA accounts, but once deposited the funds become traditional IRA assets.
When to withdraw:
The employee is always completely vested in the account which means that the contributions immediately belong to them. Required disbursements begin at 70 ½2 however the account holder can withdraw from the account penalty-free starting at 59 ½2. If there are no alternatives to a financial crisis, the account holder can withdraw from the account before 59 ½,2 but they will incur an additional 10% tax.
Why create a SEP IRA:
Traditional IRA’s have contribution limits of $5,5001 with a $1,000 1 increase for those over 50 years old. The SEP IRA contribution limit is the lower of 25%1 of the employee’s income or $54,0001. This is incredibly advantageous for those who are self-employed as they can take a tax deduction for their business while earning relatively large sums of tax-deferred income for themselves. For small business owners, the tax deduction and employee goodwill can also make the creation of a SEP IRA attractive. A large advantage of the SEP IRA is that they are far less restrictive with regards to which stocks, bonds, mutual funds, and ETFs can be invested in than 401(k)s.
- John lives in Portland where owns a small consultancy firm with 3 employees. John pays himself $250,000 in salary while his employees earn $100,000. He wants to help his employees while reducing his company’s tax liability so he sets up a SEP IRA plan. In 2017, John’s firm had an awesome year so he decides to contribute the maximum amount through the SEP IRA. He contributes $54,000 (250,000*.25=62,500>54,000) to his own SEP and $25,000 to his employees’ SEPs (100,000*.25=25,000<54,000). In 2018, John’s company takes a beating so he decides to forgo any contribution for the year. In 2019, the firm does pretty well, but John is cautious so he only contributes 5%. He gets $12,500 and his employees each receive $5,000.
- John undergoes an emergency appendectomy on his 45th birthday but doesn’t have sufficient liquidity to pay for the procedure so he withdraws money from his SEP IRA. He needs $10,000 for the procedure so he has to withdraw $15,290 which is taxed at 52.9% (2017: 33% US, 9.9% OR, 10% penalty).
- John retires at 59 ½ to pursue his goal of climbing Mt. Whitney. He needs $10,000 to get equipment and a mountain guide so he withdraws $14,290 from his SEP IRA.By age 70 ½, John has $100,000 in his SEP IRA so he’s required to withdraw at least $3,649.64. This is calculated by dividing the balance of the IRA or SEP IRA by the distribution period as defined by the IRS.
|Age||Distribution Period||Age||Distribution Period||Age||Distribution Period||Age||Distribution Period|
|79||19.5||91||10.8||103||5.2||115 and over||1.9|
If you’re interested in setting up a SEP IRA or want more information, please contact us by phone at (503) 747-6534, or by e-mail at email@example.com.
1 These are the limits as of 2017. They are subject to IRS rules and regulation changes.
2 Ages for penalties and required minimum distributions are subject to IRS rules and regulation changes.
3 All examples are intended to be an estimation, and can change based on rules and regulation.