What is a SEP IRA?

SEP IRA (Simplified Employer Pension Plans) are retirement plans that are ideal for small business owners and self employed individuals. A SEP IRA allows individuals to make contributions of up to $49,000 for 2010 into their own and their employees' retirement accounts.

SEP IRA Eligibility

Incorporated and unincorporated businesses are eligible. Sole proprietors, independent contractors, partnerships, LLCs, Subchapter S and C corporations qualify. Also, individuals with self employed income may be able to contribute to a SEP even if they are already covered by a retirement plan (i.e. 401(k) or 403(b)) through their full time employer. There is no upper age limit to establishing a SEP IRA.

When is the deadline for a SEP IRA to be established and funded?

Sole proprietorship, partnership or a LLC taxed as a sole proprietorship- A SEP must be established and funded by the individual's personal tax filing deadline, generally April 15th (or October 15 if an extension was filed).

S or C corporation or a LLC taxed as a corporation - A SEP must be established and funded by the corporate tax filing deadline, generally March 15th (plus extensions).

SEP IRA for a self employed individual with no employees.

Contributions of up to 25% of compensation up to a maximum of $49,000 in 2010 can be made into a SEP. For incorporated businesses, compensation is based on W-2 income and for sole proprietors it is based on "adjusted earned income." Adjusted earned income is determined by completing an IRS worksheet. SEP contributions of 20% of adjusted earned income can be made for sole proprietors. Annual compensation of more than $245,000 in 2010 cannot be taken into consideration for determining contributions.

Contributions into a SEP IRA are tax deductible and the percentage of contribution can vary on a year by year basis.

Self employed individuals should also consider an Individual 401(k) as an alternative to a SEP IRA. When compared to a SEP IRA, an Individual 401(k) may allow a greater contribution at the same income level due to the way the contribution is calculated.

SEP IRA versus Individual 401(k): Which self employed retirement plan is better for you?

Compare the features of these retirement plans and determine which plan is more appropriate based on your situation SEP IRA vs. Individual 401(k).

SEP IRA for a small business owner with employees.

With a SEP, contributions are made by the employer (employees do not contribute). All eligible employees have their own individual SEP accounts and annual contributions are made by the employer. The employer can elect to contribute between 0% to 25% of compensation and the percentage of contribution can vary annually at the employer's discretion. The employer and all eligible employees must receive the same fixed percentage. The annual contribution made by the employer is tax deductible.

Who is considered to be an eligible employee?

Employers must make contributions to employees if they meet the following 3 requirements:

1. 21+ years old
2. Have at least 3 years of service in last 5 years
3. Have earned at least $450 in compensation from the employer for the year.

Employers who would like to sponsor a retirement plan for their employees but are financially unable to make contributions on their behalf may want to consider a 401(k) plan. With a 401(k), employers are not required to contribute and contributions can be made solely by employees.