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SEP IRA

SEP IRA enables a sole proprietor or small business to offer a flexible, low maintenance and cost effective retirement savings program while receiving a federal tax deduction.

Overview

Overview


This material is intended as general information only and is not intended as legal or tax advice. Some of this information may be quite complex and we strongly suggest you consult with your advisor or tax professional based on your individual situation.

What is a SEP IRA?

A Simplified Employer Pension (SEP) is an IRA based plan that allows small business owners and their employees to save for retirement on a tax-deferred basis.

How does a SEP IRA work?

Employers fund up to 25% of eligible employee compensation on a discretionary basis up to $56,000 (2019) annually. The employer completes IRS Form 5305-SEP to establish a SEP IRA plan. Generally, the employer is not permitted to sponsor a qualified retirement plan alongside a SEP IRA.

Each eligible employee establishes their own SEP IRA. A SEP contribution can be comingled with an employee’s traditional IRA account, but not Roth or SIMPLE IRA.

Who should consider a SEP IRA?

  • Business owner who wants to reduce current taxes while saving for retirement
  • Business owner looking for a flexible and low-cost retirement savings program
  • Business owner who wants to attract and reward employees by offering an attractive retirement savings option
  • Business owner who wants contribution flexibility. SEP IRA contributions are discretionary.

 

Eligibility

Eligibility


This material is intended as general information only and is not intended as legal or tax advice. Some of this information may be quite complex and we strongly suggest you consult with your advisor or tax professional based on your individual situation.

What type of business is eligible to establish a SEP IRA?

A SEP IRA may be established by any of the following business types:

  • Sole-proprietor
  • Self-employed
  • Partnership
  • Limited Liability Corporation (LLC)
  • Non-profits


Who is an eligible employee?

An employer must include any employee who satisfies the following criteria:

  • Worked for the employer for at least three of the preceding five years and earned at least $600 per year and has attained 21 years of age.


An employer may but is not required to cover the following employees:

  • Don’t satisfy the age and service requirements (see above) or
  • Employees covered by a collective bargaining agreement
 

Contributions

Contributions


This material is intended as general information only and is not intended as legal or tax advice. Some of this information may be quite complex and we strongly suggest you consult with your advisor or tax professional based on your individual situation.

How much can be contributed to a SEP IRA?

A SEP IRA is funded solely with employer contributions that are 100% immediately vested.

Employer contributions are limited to the lesser of:

25% of compensation or

$56,000 (2019)

When can contributions be made to a SEP IRA?

A business owner can establish and fund a SEP IRA as late as their business tax filing deadline plus extension.

Who is required to receive a SEP IRA contribution?

All employees who satisfy SEP IRA eligibility requirements even if service separation occurs prior to the contribution being made.

EXAMPLE:

John, age 21, has been an employee of P&Q Inc. since January 2015. He severs employment in November 2015. John, assuming P&Q Inc. makes a SEP IRA contribution in 2016 (for the 2015 tax year) will receive a contribution based on his 2015 compensation.

Can an investor rollover a retirement account from a former employer?

Yes. SEP IRAs accept rollovers from most former employer plans including other SEP IRAs, SIMPLE IRAs; 401(k), 403(b), and 457(b) government plans.

Can an investor contribute to both a SEP IRA and traditional IRA?

Yes. A traditional IRA contribution is in addition to any contribution an employer makes to a SEP IRA. In 2019, the traditional IRA limit is $6,000 and $7,000 for those investors age 50 and over.

Practice Tip: The same rules and contribution limits apply if you qualify to fund a Roth IRA.

Are SEP IRA contributions tax deductible to the employee?

For a time a SAR-SEP IRA was available as retirement plan option for a small business owner. A SAR-SEP IRA allowed eligible employees to make pretax salary deferrals up to certain limits. No new SAR-SEPs could be established after December 31, 1996; although previously established accounts are grandfathered. If you have questions in regards to transferring a SAR-SEP to Lord Abbett, please call our Retirement Specialists at 888-522-2388.
 

Distributions

Distributions


This material is intended as general information only and is not intended as legal or tax advice. Some of this information may be quite complex and we strongly suggest you consult with your advisor or tax professional based on your individual situation.

What types of distributions can be taken from a SEP IRA?

There are a number of different kind’s distributions that can be taken from a SEP IRA. We discuss each type below.

  • Normal
  • Premature (without an exception)
  • Premature (with an exception)
  • Required Minimum Distribution (RMD)
  • Distribution due to death


What is a normal distribution from a SEP IRA?

A normal distribution occurs after the account owner attains age 59½. A normal distribution is generally subject to taxation in the year withdrawn (unless the withdrawal includes aftertax dollars) but the 10% early withdrawal penalty tax does not apply.

What is a premature distribution (without an exception)?

A premature distribution (without an exception) from a SEP IRA occurs upon the account owner withdrawing funds before age 59½ and exceptions apply. A premature distribution is both taxable and subject to a 10% early withdrawal penalty tax.

What is a premature distribution (with an exception)?

A premature distribution (with an exception) occurs upon the account owner withdrawing funds before age 59½ and having the distribution satisfy an exception. A premature distribution (with an exception) is subject to taxation but the 10% early withdrawal penalty tax does not apply.

Common exceptions to the 10% additional tax on early withdrawals are:

  • Substantially Equal Periodic Payments (“72(t)”) 
  • Disability
  • Death 
  • Qualified higher education expenses 
  • Pay for health insurance premiums after receiving unemployment benefits for more than 12 weeks
  • Unreimbursed medical expenses (greater than 7.5% of adjusted gross income)
  • First-time home purchase (subject to a lifetime limit of $10,000)
  • IRS Levy


What is a required minimum distribution from a SEP IRA?

A SEP IRA account owner is required to take a minimum distribution the year they turn age 70½. The minimum distribution rules permit the initial or first minimum distribution to be deferred until April 1st of the following year. Delaying an RMD requires the account owner to take two RMDs the following year.

EXAMPLE: Jim turns 70½ in 2018. He can either take his RMD in 2018 or delay it until April 1st 2019. Assuming Jim elects to delay his 2018 RMD, he is required to take two RMDs in 2019 (his 2018 deferred RMD and 2019 RMD). All subsequent RMDs must be taken annually by December 31st

If the full RMD is not taken in a given year, a 50% excess tax is assessed on the amount not taken. See our calculator to determine your annual RMD amount.

Practice tip: An investor 70½ or older is eligible to participate assuming SEP IRA eligibility requirements have been satisfied. However, the investor must also take minimum distributions.

What is the 60-day withdrawal and rollover rule?

Once in a 12-month period, an IRA account owner may withdraw any amount, for any reason, from any of his/her IRAs and repay the IRA within 60 days without be subject to taxation or an early withdrawal penalty. If not repaid in the allotted 60-day time frame, the account owner will be subject to potential taxation and penalties.

Recent guidance clarifies that one IRA Rollover per year now applies on a per taxpayer basis – not per IRA. Therefore, an individual can elect a single 60-day withdrawal and rollover in a 365-day period regardless of the number or types of IRAs owned.

What death benefits are available from a SEP IRA?

When a SEP IRA account owner dies, an inherited or beneficial IRA is created. However, inherited IRA treatment differs depending on who inherits the account. SEP IRAs inherited by a surviving spouse differ from a non-spouse beneficiary.

Spousal beneficiary:

Spousal beneficiary has the following options available upon inheriting a SEP IRA:

  • Treat the account as your own.
  • Rollover the IRA into your own IRA.
  • Transfer the IRA to an employer sponsored plan that you are a participant.
  • Remain a beneficiary.


Non-Spouse Beneficiary

Inheriting a SEP IRA from someone other than a spouse provides more limited options. 

Non-spouse beneficiary has the following options available upon inheriting a SEP IRA:

  • Liquidate the entire account.
  • Make withdrawals equaling the entire account value by the end of the fifth calendar following the account owner’s death.
  • “Stretch” withdrawals over the beneficiary’s life expectancy.


What is a Stretch IRA?

A Stretch IRA is a distribution strategy available to an IRA beneficiary. The beneficiary “stretches” withdrawals over the beneficiary’s life expectancy.

Click here for more information on our Stretch IRA

We also offer a calculator to assist in providing you minimum payout amounts

Can I convert my existing SEP IRA(s) to a Roth IRA?

Yes. All investors, regardless of age or income, including those with SEP and SIMPLE IRAs (2-year hold period must be satisfied) are eligible to convert all or a portion of their assets to a Roth IRA. Distributing pretax IRA assets to a Roth IRA via a conversion is a taxable event – subject to taxation in the year the conversion takes place. However, if the account is held for five years and until age 59½ all proceeds, including earnings are distributed free of income taxes.


Risks Involving the Stretch IRA Strategy: 
Withdrawals by the account holder or beneficiaries in excess of the required minimum distribution (RMD) will exhaust the account at a faster pace, reducing or eliminating the effectiveness of the stretch strategy. Distributions greater than the RMD could subject the payment to higher federal and, possibly, state income taxes. When investing assets, which will be used to stretch IRA payments, the investor must be cognizant of any front-end or back-end sales charges that can reduce the assets available. During an extended period of declining investment returns, investors will experience income fluctuations that may cause additional withdrawals to be made that will exhaust the account at a more rapid rate. There can be no guarantee that a stretch IRA strategy will be advantageous to your specific situation, and many of its benefits are based on current tax laws, which are subject to change. If these laws change in the future, an investor's ability to maintain estimated distributions may be affected. Lengthy distribution periods, much like those involved in a stretch IRA, expose an investor to significant market risk.

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