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What is a SEP IRA, Advantages, and Contribution Limits

What is a SEP IRA, Advantages, and Contribution Limits

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SEP IRA is one of the many retirement plans designed to help self-employed individuals and small-business owners save for their retirements. With a SEP IRA, you can contribute up to 25% of your income with a maximum contribution limit of $50,000 for the 2012 tax year, and $51,000 for 2013. Contributions are tax deductible and your savings grows tax-deferred until withdrawn. Upon withdrawal, or conversion to a Roth IRA, you will pay taxes on the amount withdrawn or converted at your regular tax rate.

SEP IRA

You are eligible to contribute to a SEP IRA if you are a sole proprietor, in a partnership, or a business owner.  Also, you are eligible if you earn any self-employed income, even if you are already covered by a retirement plan at your full-time job. The contribution deadline is usually April 15 of the following year — i.e., you have up to April 15, 2013 to contribute to your 2012 SEP IRA.

Contribution Limits

As mentioned above you can contribute the lower of 25% of your income or $50,000 for 2012 tax year (and $51,000 for 2013). For example, if you earned $100,000 eligible income, you can contribute $25,000 to SEP IRA (because you hit the 25% limitation). On the other hand, if you earned $400,000, you can contribute $50,000 (because you hit the maximum amount limitation).

Advantages of SEP IRA

  • Contributions to SEP IRA are deductible for income taxes purpose.
  • Your investment grows tax-deferred until withdrawn.
  • Wide investment options similar to Traditional IRA and Roth IRA.
  • Easy to set up. Any brokerage firm or financial institution will be able to assist you.
  • You can contribute to SEP IRA in addition to other retirement plans, such as 401(k), Traditional IRA and Roth IRA
  • No phase out limitation regardless of your income.

Limitations of SEP IRA

  • Contribution limit is 25% of your compensation.
  • There is a maximum contribution limit of $50,000 for the 2012 tax year, and $51,000 for 2013.
  • You must have a written agreement to provide benefits to all eligible employees. Note the name, Simplified Employee Pension Plan
  • There is 10% early withdrawal penalty fee if you withdraw any money before you reach the age of 59 1/2.

Alternatives to SEP IRA

In addition to SEP IRA, there are a few more retirement savings options that I’ll be exploring in future articles. These include:

  • Keogh Plan
  • SIMPLE IRA
  • Solo 401(k) Plan

Overall, SEP IRA is one of the best retirement savings plans for a self-employed individuals.

4 thoughts on “What is a SEP IRA, Advantages, and Contribution Limits”

  1. Nice to see that this type of product is deductable for income tax purposes, so many current savings products seem to have this element. Might be something to do with the global economy and the impetus to spend spend spend our way out of the financial crisis…..

  2. Good post, well-written and very informative. One thing I would add, one of the downsides of the SEP is that if you have a down year income-wise, but have the cash available, the amount of your contribution is limited. For this reason and some others I generally prefer the Solo 401(k). However the SEP is nice in that first year in that you can wait until your file your taxes on extension to establish the account.

  3. So can you have both a SEP IRA and a Regular IRA contribution in a single year? I want to be able to get both deductions

    • @DGI – You can contribute to both, but your regular IRA contributions are subjected to the phase-out limitation.

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