A Simplified Employee Pension (SEP) plan is one of the most popular retirement plans for self employed individuals and small business owners. It is popular because it allows business owners to make tax deductible contributions. Employees also find this retirement plan attractive because they do not pay tax on their contributions. They also receive fringe benefits tax-free. The following are SEP IRA rules in detail.
Any employer, whether a partnership, sole proprietor, nonprofit or corporation, can establish an SEP provided they have at least one employee. Employees cannot establish their own SEP. What they can do is open a Traditional IRA for their employer to deposit SEP contributions. However, small business owners can set up an SEP and get SEP contributions as employees of their own firm. Only employees who have attained the age of 21 qualify. Furthermore, an employee must have worked for the employer for at least three years within the last five years to qualify. An indexed income of $550 per year is a requirement.
Rules on Contributions
Employees who receive over $255,000 annually are not eligible for SEP contributions. Employers can contribute up to 25 percent of their employee’s salary, provided the contribution does not exceed $51,000 (for 2013). Employers cannot make contributions exceeding the limit set for that year, i.e $52,000 for 2014.
It is important to note that once the employer makes SEP contributions, they are credited to their employees’ Traditional IRAs and they become Traditional IRA assets. For this reason, traditional IRA rules apply during distribution, which can be done at any time, but there are penalties for making a early withdrawals before the account holder attains the age of 59.5 years. For instance, early distribution attracts a penalty of 10 percent. Account holders must also pay income tax during distribution regardless of the maturity of the account.