There are dozens of choices when it comes to saving for your retirement, and the options can often be confusing. A SEP IRA is a specialized type of retirement savings vehicle with its own set of rules such as annual contribution limits and employee contributions.
What is a SEP IRA?
SEP stands for simplified employee pension plan. It provides a simple way that employers can make contributions toward an employee's retirement savings, according to the Internal Revenue Service. Contributions made to a SEP are held in an IRA, or individual retirement account, until the employee is eligible to withdraw retirement funds. The money grows tax deferred until the employee reaches retirement age, and withdrawals made after age 59 1/2 are taxed at the normal income tax rate.
Setting Up a SEP IRA
A SEP must be established with a written SEP agreement such as the IRS Form 5305-SEP, Simplified Employee Pension -- Individual Retirement Accounts Contribution Agreement. The employer must provide a copy of the agreement and relevant information regarding the SEP plan to each eligible employee. Eligible employees must be at least 21 years of age and as of 2010 and 2011, they must have received a minimum of $550 in compensation from the employer during the calendar year.
A SEP IRA is designed for employer contributions only. Although the employee owns and controls his own SEP IRA, the employer sends contributions to the account directly through the financial institution responsible for maintaining the SEP. Should they choose, employees are eligible to participate in additional retirement savings plans including both private and employer-sponsored IRA or 401k plans.
Making Your Own Contributions
Technically, you can contribute to your own SEP IRA account as a self-employed individual or small business owner. SEP IRA's can be established by an employer with multiple employees but are commonly used for self-employed and independent business owners to establish retirement savings. Rules for 2010 and 2011 allow a maximum employer contribution of up to $49,000 per year, according to investment specialist Beacon Capital Management Advisors. If you receive a W-2 salary as the owner of an S or C corporation, you may contribute up to 25 percent of your salary or up to 20 percent of your net adjusted income as a sole proprietorship or limited liability company.
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