SEP IRA
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A Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) is a variation of the
Individual Retirement Account An individual retirement account (IRA) in the United States is a form of "individual retirement plan", provided by many financial institutions, that provides tax advantage Tax advantage refers to the economic bonus which applies to certain accounts ...
used in the
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United States
. SEP IRAs are adopted by business owners to provide retirement benefits for themselves and their employees. There are no significant administration costs for a self-employed person with no employees. If the self-employed person does have employees, all employees must receive the same benefits under a SEP plan. Since SEP-IRAs are a type of IRA, funds can be invested the same way as most other IRAs. The deadline for establishing the plan and making contributions is the filing deadline for the employer's tax return, including extensions. The strictest conditions employers may place on employee eligibility are as follows. The employee must be included if they have: # attained age 21 # worked for the employer in three of the previous five years # received at least $650 in compensation for tax year 2021 ($600 for 2019 and for 2020) Employers may use less restrictive criteria. SEP-IRA funds are taxed at
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tax rates when qualified withdrawals are taken after age (as for traditional IRAs). Contributions to a SEP plan are deductible, lowering a taxpayer's income tax liability in the contribution year.


Contribution limits

SEP-IRA contributions are treated as part of a profit-sharing plan. For employees, the employer may contribute up to 25% of the employee's wages to the employee's SEP-IRA account. For example, if an employee earns $40,000 in wages, the employer could contribute up to $10,000 to the SEP-IRA account. The total contribution to a SEP-IRA account should not exceed a) the lesser of 25% of income (20% for self-employed before self-employed tax deduction is included;
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)); or b) $42,000 (for 2005), $44,000 (2006), $45,000 (2007), $46,000 (2008), $49,000 (2009–2011), $50,000 (2012), $51,000 (2013), $52,000 (2014), $53,000 (2015–2016), $54,000 (2017), $55,000 (2018), $56,000 (2019), $57,000 (2020), or $58,000 (2021). For 2010 and 2011, the compensation used in the calculation was capped at $245,000 (e.g., an employer making a 10% contribution cannot contribute more than $24,500 for any employee).


Self-employed

The contribution limit for self-employed persons is more complicated; barring limits, it is 20% of net profit. The computation is in IRS Pub 560, section 5, ''Table and Worksheets for the Self-Employed'', specifically ''Rate Worksheet for Self-Employed''. Two complications are: *
Federal Insurance Contributions Act tax The Federal Insurance Contributions Act (FICA ) is a United States The United States of America (USA), commonly known as the United States (U.S. or US), or America, is a country Contiguous United States, primarily located in North America ...
(FICA) *Reduced rate


FICA tax

SEP contribution limits are computed not from net profit but from net profit ''adjusted'' for the deduction for self-employment tax (2019
Form 1040 Form 1040 (officially, the "U.S. Individual Income Tax Return") is an IRS tax forms, IRS tax form used for personal federal income tax returns filed by United States residents. The form calculates the total taxable income of the taxpayer and determ ...
Schedule C, line 31; 2019 Form 1040, Schedule F, line 34; or 2019 Form 1065, Schedule K-1, box 14, code A). Barring limits, this is half the 15.3% FICA tax, levied on net earnings, which is 92.35% of net profit. Therefore, adjusted net profit (net profit minus deduction for self-employment tax) is 92.935225% of net profit, which is close to but slightly more than net earnings.


Reduced rate

The limit of 25% applies to wages, not (adjusted) net profit. In the above example, where an employee earns $40,000 and the employer contributes 25% of that, $10,000, the employee has received $50,000 total, of which 20% goes to the SEP-IRA. When a business is a sole proprietorship, the employee/owner both pays themselves wages and may also make a SEP contribution, which is limited to 25% of ''wages'', namely, profits minus SEP contribution. For a particular contribution rate ''CR'', the reduced rate is ''CR/(1+CR)''; for a 25% contribution rate, this yields a 20% reduced rate, as in the above.


Overall

Thus, the overall contribution limit (barring limits) is 20% of 92.9% (that is, 18.6%) of net profit. For example, if a sole proprietor has $50,000 net profit from self-employment on Schedule C, then the "1/2 of self-employment tax credit", $3,532, shown on adjustments to income at the bottom of
form 1040 Form 1040 (officially, the "U.S. Individual Income Tax Return") is an IRS tax forms, IRS tax form used for personal federal income tax returns filed by United States residents. The form calculates the total taxable income of the taxpayer and determ ...
, will be deducted from the net profit. The result is then multiplied by 20% to arrive at the maximum SEP deduction, $9,293.


Withdrawal Rules

SEP contributions and earnings are held in SEP-IRAs and can be withdrawn at any time, subject to the general limitations imposed on
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. A withdrawal is taxable in the year received. If a participant makes a withdrawal before age 59½, generally a 10% additional tax applies. SEP contributions and earnings may be rolled over tax-free to other
Individual retirement account An individual retirement account (IRA) in the United States is a form of "individual retirement plan", provided by many financial institutions, that provides tax advantage Tax advantage refers to the economic bonus which applies to certain accounts ...
and retirement plans. SEP contributions and earnings must eventually be distributed following the IRA required IRA Required Minimum Distributions.


See also

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401(k) In the United States, a 401(k) plan is an employer-sponsored defined-contribution pension A pension (, from Latin Latin (, or , ) is a classical language belonging to the Italic languages, Italic branch of the Indo-European languages. Lat ...
*
457 planThe 457 plan is a type of nonqualified, tax advantage Tax advantage refers to the economic bonus which applies to certain accounts or investment To invest is to allocate money Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricatu ...
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Roth IRA A Roth IRA is an individual retirement account (IRA) under United States law that is generally not Taxation in the United States, taxed upon distribution, provided certain conditions are met. The principal difference between Roth IRAs and most other ...
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SIMPLE IRA A Savings Incentive Match Plan for Employees Individual Retirement Account, commonly known by the abbreviation "SIMPLE IRA", is a type of tax-deferred employer-provided retirement plan in the United States that allows employees to set aside money an ...
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Solo 401(k) A Solo 401(k) (also known as a Self Employed 401(k) or Individual 401(k)) is a 401(k) qualified retirement plan for Americans that was designed specifically for employers with no full-time employees other than the business owner(s) and their spouse ...
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Traditional IRAA traditional IRA is an individual retirement arrangement (IRA), established in the United States The United States of America (USA), commonly known as the United States (U.S. or US), or America, is a country Contiguous United States, primar ...
*
Form 1099-R In the United States, Form 1099-R is a variant of Form 1099 used for reporting on distributions from Pensions in the United States, pensions, Annuity (American), annuities, Retirement plans in the United States, retirement or profit sharing plans, I ...


References


External links


IRS Pub 590 (Individual Retirement Arrangements)IRS Form 5305 (SEP Agreement)
{{DEFAULTSORT:SEP IRA Individual retirement accounts Retirement plans in the United States