Yes. The SEP IRA is just a traditional IRA that receives employer SEP contributions, and it operates by the same rules.

Just to clarify:

  • A traditional Individual retirement account (IRA) is a long-term savings plan that allows a person or couple with taxable income to invest a portion of annual gross income up to a set maximum each year. That money is not subject to income tax in that year, and the money is not taxed as it accrues from year to year. When the account owner retires and starts taking money out, it is taxable as ordinary income.
  • A Self-Employment Plan (SEP) IRA is a variation that is designed for freelancers and for small business owners with at least one employee. Unlike in a traditional IRA, an employee cannot contribute to the fund. But the employer may contribute to an employee's fund as well as to his or her own fund.

The SEP IRA is intended to be easy to set up and flexible to use. For example, an employer can decide at the end of the year whether to make a contribution and how much. (The employer cannot contribute only to his or her own fund but must make a contribution to any eligible employees' funds as well.)

Key Takeaways

  • A SEP IRA is a type of traditional IRA designed for freelancers and small business owners.
  • As with any traditional IRA, you can convert the account to a Roth IRA.
  • Just remember, you'll owe income taxes for that tax year on the entire balance.

Understanding the SEP IRA

Like a traditional IRA, a SEP IRA can be opened at just about any bank, financial institution, personal investing firm, or online trading platform. A vast variety of investment options is available, from conservative bond funds to aggressive growth stock funds.

This is not just any account, though. It is a special IRA account, and what makes it special is that it is endorsed by the Internal Revenue Service as a retirement savings vehicle with federally-approved tax benefits.

The IRA is, by definition, a tax-deferred savings vehicle. There are benefits to you and your employees:

To convert a SEP IRA, contact the financial institution that manages the money. You can rollover the money there or at any other company that offers IRAs.

Taxes on money contributed to the account are delayed until the money is withdrawn, presumably after retirement. Your taxable income, and that of your employees, is reduced for that year. So, the actual hit on your net income is less than it would have been had you simply opened a savings account to stash your money in. Moreover, you're not taxed on the profit from year to year. All of the taxes are due only when you withdraw money.

A traditional IRA is called "traditional" to distinguish it from the other main type of IRA, the Roth.

Converting a SEP IRA to a Roth IRA

A Roth IRA has one main difference from a traditional IRA: The taxes are paid up front. That is, you pay in after-tax earnings, getting no immediate tax deduction. But you never owe taxes on that money again, principal or profit, when you withdraw the money after retirement.

When you convert any traditional IRA, including a SEP IRA, to a Roth account, you owe taxes on the balance in that tax year. This is considered sound retirement planning, if you can afford to pay the taxes now instead of owing them later, after retiring. This is especially true if you expect to be in a higher tax bracket after you retire.

Another benefit of the Roth IRA is that you will not be required to make minimum annual withdrawals, as with a traditional IRA. The IRS has already taken its cut and therefore doesn't care if or when you use the money.

Finally, the Roth IRA has no penalties for early withdrawal. If you absolutely must raid your retirement account before you retire, you can.

How-To

In order to convert to a Roth IRA, contact the financial institution that manages your SEP or other traditional IRA account. In IRS-speak, this is the trustee for the account. You can rollover the money into a Roth account at that institution, or somewhere else if you choose.

In any case, make sure you request a rollover. You do not want that money paid into your hands. Even if you don't use it you could face early withdrawal penalties.