Simplified employee pension individual retirement accounts are tax-deferred retirement savings plans designed to allow business owners a simpler method of contributing to employee accounts. In essence, a SEP IRA is a collection of traditional IRAs organized under one broad employer plan that allows for employer contributions – something that traditional IRAs cannot feature. There are fairly standard tax benefits for employer contributions, and most of the tax rules for the individual accounts are the same as with traditional IRAs.
SEP IRA Taxes for Employers
Employers are allowed to make annual contributions to their employees' individual accounts as long as they do not exceed the lesser of $52,000 (as of 2014) or 25% of total employee annual compensation.
A self-employed business owner who establishes a SEP IRA must use a special calculation provided by the Internal Revenue Service to determine contribution limits towards his or her own account.
Generally, 100% of all employer contributions are tax-deductible to the business. If the total contributions exceed 25% of all employees compensation, however, the surplus would not be deductible on the business tax return.
If a SEP IRA fails to meet the plan's requirements as set forth in the Internal Revenue Code, the tax benefits to the business are forfeited. The only way to avoid the loss of tax privileges is to complete one of the IRS correction programs.
SEP IRA Taxes for Employee Accounts
The tax-deferral benefits for an employee's SEP IRA are similar to those of traditional IRAs: Contributions to the account are made with pre-tax earnings, and all investment growth in the account occurs tax-free. Once an individual reaches age 59.5, he or she becomes eligible to withdraw funds from the SEP IRA without incurring a tax penalty. The penalty for premature withdrawals is 10%.
Once funds are withdrawn, they are subject to normal income taxes. If they are prematurely withdrawn, the 10% penalty is assessed and then income taxes are taken out. If a distribution is made for unreimbursed medical expenses and exceeds 10% of the individual's adjusted gross income, the distribution is not subject to early withdrawal penalties. There are similar exceptions for account owners who become disabled and for those who need to pay for medical insurance.
Like traditional IRAs and any qualified account with pre-tax contributions, a SEP IRA carries a required minimum taxable withdrawal on an annual basis beginning the tax year after the account owner turns 70.5. The amount of the minimum withdrawal is calculated by the IRS based on the year-end account balance and the life expectancy of the account owner.
Employees have the option of rolling over their SEP IRA funds into another qualified account, such as a regular IRA, without incurring any additional tax penalties.