SEP IRA Basics

What is a SEP IRA?

An SEP-IRA is a variation of the traditional IRA and is used by small businesses to provide retirement benefits for its business owners and their employees. SEP-IRAs do not require the start up costs that conventional retirement plans have and allows contributions of up to 25% of each employees pay.

Advantages to SEP-IRAs

The biggest advantage to SEP-IRAs over other types of IRAs is that the start up and administrative costs are very low. A business can even qualify for tax credits up to $500 a year for the first 3 years to make up for costs incurred by starting an SEP-IRA. Another great advantage is, in most scenarios, you don’t have to file one piece of red tape / documents with the government. They are extremely flexible in terms of who is allowed to set up an SEP-IRA. Sole proprietors, partnerships, and corporations, including S corporations, can set themselves up with an SEP-IRA and provide retirement benefits for they’re companies and employees at a relatively low cost. A business is not locked into a set contribution each year or required to make contributions each year, in fact, they decide each year if they will make contributions on behalf of they’re employees and how much they contribute.

Employee Eligibility

An employee is not someone who simply works for a company in respect to SEP-IRAs, an employee is anyone who works for a company, owns a company, or is self employed.

To be eligible to participate in an SEP-IRA one must be 21 years of age and has worked for a company at least 3 years out of the past 5 years. All employees that meet these qualifications must participate. This includes part timers, seasonal employees, or employees who have died or terminate employment during that year.

SEP-IRAs may also cover employees covered by a union contract, nonresident alien employees who did not earn income from the company, and employees who earned less that $550 during the year.

How to Open a SEP-IRA

A SEP-IRA may be set up before the due date of a businesses income-tax return for that calendar year, including any extensions. A business can open a SEP-IRA by getting in touch with a retirement plan professional at financial institutions that offer retirement plans. You should ask for Form 5305-SEP or an equivalent. This financial institution can be a bank, mutual fund, an insurance company, or any other financial institution approved by the government.


A participant cannot take a loan of any monies against their SEP-IRA, though they are allowed to make withdrawals tax-free if they are age 59 1/2 or older. In most cases, if they take out a distribution (withdrawal) before turning 59 1/2 years of age they will be charged a 10% tax on monies distributed.

SEP-IRA funds can be rolled over into other retirement plans tax-free, such as, another SEP-IRA, Traditional IRA, Simple IRA, or any other employer’s qualified retirement plan.

Just like the more traditional IRA, you have to start taking out distributions (withdrawals) after you reach the age of 79 1/2 or you will face a huge penalty.

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