SEP IRAs

The Simplified Employee Pension (SEP) IRA is a tax-deferred retirement plan that self-employed people and employers — which include self-employed individuals in sole proprietorships or partnerships — can use to save for retirement for themselves and/or their employees. A SEP IRA may be appropriate if you have income from full- or part-time self-employment, or if you're an employee of someone who establishes a SEP IRA for his or her employees.

Because SEP IRAs have high contribution limits — up to $49,000 in 2011 — they are a popular investment vehicle among people with full- or part-time income from self-employment. And because they have minimal administrative requirements, SEP IRAs are also easy to establish and maintain.

SEP IRA Eligibility Rules

You are eligible to establish a SEP IRA if you are an employer or are self-employed. Also, you can open a SEP IRA even if you’re covered by an employer-sponsored retirement plan.

Contribution Rules and Limits

In 2011, SEP IRA contributions can equal 25% of compensation, up to a limit of $49,000, and are completely tax deductible. In cases of small businesses covered by a SEP plan, all contributions must be made by the employer, who must contribute the same percentage of compensation for each eligible employee, including him- or herself. For self-employed individuals, compensation must come from their net earnings.

Potential for Tax-Deferred Growth

Earnings in a SEP IRA grow tax deferred until withdrawn in retirement. Withdrawals after age 59½ are taxed at your ordinary income tax rate. Withdrawals prior to age 59½ are subject to ordinary income tax, as well as an IRS 10% early withdrawal penalty. However, the IRS will waive this penalty when distributions are used for:

  • Certain unreimbursed medical expenses
  • Medical insurance, provided certain conditions are met
  • A disability, if certain conditions are met
  • Payments to designated beneficiaries in the event of the death of the IRA owner
  • Payments received under a Substantially Equal Periodic Payment Plan over a five-year period or until age 59½ (whichever is longer)
  • Qualified higher education expenses
  • The purchase or the building of a first home
  • Qualified reservist distributions

In addition to SEP IRAs, people with self-employment income are also eligible for Keogh plans, which offer certain advantages not available from SEP IRAs.

The tax information in this article is not intended to be used, and cannot be used, to avoid possible tax penalties. It was written to promote the products and services the article describes. Neither TIAA-CREF nor its affiliates offer tax advice. Taxpayers should consult an independent tax advisor for advice based on their own particular circumstances.

© 2013 and prior years, Teachers Insurance and Annuity Association - College Retirement Equities Fund (TIAA-CREF), New York, NY 10017