Setting Up and Maintaining a SEP IRA

A Simplified Employee Pension Plan, also known as a SEP IRA is a popular retirement plan that was designed specifically for people that are self employed. As the name implies these plans are easy to administer with no complicated forms or annual required filings with the IRS.

A SEP IRA may be established for sole proprietors, partnerships and owners of businesses including subchapter S corporations. Contributions to a SEP IRA may be made based upon net self employment income from full or part-time work even if covered by a retirement plan elsewhere. Contributions are not required to be made every year, but in years when contributions are made, they must be made for all eligible employees.

To establish a SEP IRA a formal written agreement must be executed. This agreement may be satisfied by adopting the IRS model SEP using form 5305-SEP. If there are employees they must be given a copy of the 5305-SEP form. The SEP IRA is owned and controlled by the employee. The employer sends the SEP contributions to the financial institution where the retirement account is maintained. The 5305-SEP form is kept on file and is not sent to the IRS. It must, however, be available in the event of an inquiry or audit.

Contributions to a SEP IRA allow for ongoing flexibility and can provide material tax savings as well as a smart way to accumulate funds for retirement. Investment earnings compound tax deferred and are available for distribution after age 59 ½ without the 10% IRS penalty for early withdrawal. Dispersals are taxable in the year of withdrawal.

Annual payments an employer makes to an employee's SEP-IRA cannot exceed the lesser of 25% of compensation or $46,000 for 2008 and $49,000 for 2009. Subsequent year limits are subject to annual cost of living adjustments.

Special rules apply to the self employed owners contribution to a SEP IRA. Publication 560 issued by the IRS entitled "Retirement Plans for Small Business" provides a good summary of all the rules relating to SEP IRAs including worksheets to calculate the allowable deduction for the self-employed employer. The deduction for a SEP plan for the employer cannot be more than 20% of net earnings even though the maximum rate for employees is 25%. This is due to the fact that the IRS requires the employer to adjust their compensation from net earnings by contributions made to the plan on their own behalf and for one half of self employment tax. The IRS table makes the calculation easy but this is easily overlooked and a mistake is a sure avenue for one of those dreaded letters from the IRS.

A SEP IRA can be set up as late as the due date (including extensions) of the income tax return for that year. For example, if the 2008 return is filed on August 15^th 2009 the taxpayer has until that date to set up and fund the SEP and have a deduction on the 2008 tax return.