What Are the Benefits of a SEP IRA?
Simplified Employee Pension plan individual retirement accounts, or SEP IRAs, are retirement accounts that small businesses can establish for employees and self-employed people can establish for themselves. The Internal Revenue Service (IRA) allows people to invest more money into SEP IRAs than in other kinds of retirement accounts. The plans have the same tax deferral benefits as other retirement accounts but lower costs.
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Contribution Limits
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As of 2011, the IRS allows employers to establish SEP IRAs for employees and invest the lesser of 25 percent of each employee's annual salary or $49,000 into the accounts on an annual basis. By comparison, the IRS caps annual 401k contributions at $16,500. Self-employed people can also make contributions up to the maximum limit whereas if they were to establish traditional IRAs instead, their annual contributions could not exceed $5,000 if under the age of 50 or $6,000 if over 50.
Tax Benefits
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SEP IRA contributions are made with pre-tax earnings, which means that plan participants reduce their taxable earnings by the amount of the annual contribution. The IRS affords SEP IRA plans the same tax treatment as money held in other retirement accounts such as 401k and traditional IRAs. The plan participant does not pay taxes on the principal or earnings until withdrawals are made. Account holders do not have to begin withdrawing money from the plan until they reach age 70 1/2.
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Flexibility
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Employers do not have to fund SEP IRAs every year. The amount of the contributions can change on an annual basis. The business owner can choose what kind of funds to invest the money in, but a fund trustee handles the day-to-day administration of the accounts. When an employee leaves the firm, the employee can roll funds over, tax-deferred, into another SEP IRA at a new employer. Employees can also roll SEP IRA funds into traditional IRAs without tax consequences.
Business Owner Benefits
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Many business owners qualify for a tax credit of $500 in each of the first three years after the establishment of the SEP IRA plan. The tax credit covers the cost of starting the plan. SEP IRA plans are less expensive for small businesses to run than 401k plans and business owners do not have to file annual reports to the IRS detailing fund activity. Many employees prefer to work for employers that offer some kind of retirement plan, so the SEP IRA plan helps business owners attract and retain staff.
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