A Simplified Employee Pension (SEP) is an IRA, which is funded exclusively by employer contributions. A SEP provides a means of retirement savings for self-employed persons and employees of small businesses. The SEP can be a simple alternative to more complicated and costly qualified plans.
Who is eligible to participate in a SEP IRA?
All employees that meet the following conditions are eligible to participate in a SEP IRA:
1. The employee is at least 21 years old. 2. The employee has performed services for the employer in at least three of the immediately preceding five years.
3. The employee has earned at least $600 in total compensation during the year.
4. The employee is not covered under a collective bargaining agreement.
5. The employee is not a nonresident alien.
The employer may offer less restrictive eligibility requirements than those listed above, but they may not be more restrictive.
How much may be contributed to a SEP IRA?
The employer may contribute the lesser of 25% of income or $56,000 for 2019 (subject to cost-of-living adjustments) on behalf of each eligible employee. The employer is not required to make a contribution every year, however provided that a contribution is made, the contribution must be made to all eligible participants on a non-discriminatory basis.
The contributions are excluded from the employee’s gross income and will not be reported as taxable income on the employee’s form W-2. An advantage to the SEP IRA is that contributions may continue past age 70½, provided the employee is still working. However, the required minimum distribution RMD must begin by April 1st of the following year, which age 70.
What are the restrictions on a SEP IRA distribution?
You may withdraw SEP IRA funds at any time, and income taxes will be payable on the entire amount. A 10% penalty tax may also be imposed if you are under 59½. Exceptions to this penalty tax (if under 591/2) are available. One such exception applies to those situations in which the funds are used by a first time homebuyer (subject to a $10,000 limitation). A second exception applies where a SEP IRA distribution is used for qualified educational expenses. However, ordinary income tax will be assessed upon the withdrawal. Please consult your tax advisor to determine whether these or other exceptions apply to your specific situation.
Additionally, you must begin taking required minimum distributions (RMDs) at age 70½. The RMDs are based on the owner’s life expectancy. The required beginning date for an RMD is April 1 of the calendar year following the calendar year in which age 70½ is attained.
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