Understanding SEP IRA Tax Benefits
You can establish a SEP IRA, or Simplified Employee Pension account, for both your employees and yourself if you are either self-employed or you own a small business. It can be done with minimum administration, and it can provide retirement funds for you and your employees. In addition, a SEP IRA affords many tax benefits.
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Contributions
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In 2008, an employer could make a maximum contribution of $46,000, or 20 percent of an employee's salary up to $230,000. That is one of the most generous contributions allowed by the IRS that monitors the plans. Only employers can make contributions to a SEP IRA; so, if an employee is interested in setting aside more for retirement, a regular IRA could be established, as well. For the most part, employer contributions to a SEP IRA are tax-deductible.
Tax-Free Growth
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Interest and capital appreciation accumulate without tax until an employee reaches 59 ½ years of age. If funds are then withdrawn, they are taxed as ordinary income. If withdrawals are made before reaching that age, the appreciation will be taxed as ordinary income, and you will pay a 10 percent penalty.
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Pre-59 1/2 Withdrawals
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Funds from your SEP IRA can be withdrawn under certain circumstances without the penalty before you become 59 ½ but with income tax on the appreciation or income. For example, you can pay your health insurance premiums from your SEP IRA if you have lost your job. Also, if you have significant medical expenses or are disabled, you can make penalty-free withdrawals. If you are buying your first house, up to $10,000 can be withdrawn from your SEP IRA. Because of complications in the regulations, discuss withdrawals from your SEP IRA with your tax adviser.
Mandatory Required Distributions (MRD)
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When an employee reaches his 70 ½ birthday, he must begin receiving withdrawals from his SEP IRA and pay regular income tax on the appreciation contained in those withdrawals. The IRS provides leeway the first year by allowing the taxpayer to make the taxable withdrawal by April 15th of the year following his turning 70 ½. The IRS simplified determination of MRD by providing a chart based on your life expectancy.
Warning
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The IRS receives copies of what you receive from your employer regarding the status of your SEP IRA, each year. So, if you have a SEP IRA, you need to stay current on the rules established by the IRS that governs them, particularly regarding penalties and taxability.
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