SEP-IRA - Simple to set up and administer
You could try the Simplified Employee Pension (SEP) if you wish to avoid the complexity of a qualified plan. An SEP-IRA is a written plan that allows you to make contributions to your employees' (for small business with less than 10 employees) and your own individual retirement account. It is also known as the SEP-IRA (Individual Retirement Account) Plan because a separate account has to be set up for each eligible employee. As an employer you have to make an annual contribution to each of the employee accounts.
How can you set up an SEP-IRA?
Most financial institutions would have the simple forms that you require to fill up and file. It is as easy as opening a bank account. The account is easy to administer also. Of course, if you want some degree of complexity like the integration of a social security feature then you could go for a tailor-made plan with the help of your tax consultant.
What is the last date for setting up an SEP-IRA?
You could set up an SEP-IRA even until the last date when the employer’s income tax return is due (including filing extensions). Not that we suggest that you wait till the last date.
What is the maximum amount of contribution to an SEP-IRA?
The maximum amount that you can contribute to each employee's SEP-IRA is limited to 25% of the employee's compensation but cannot exceed $49,000 for 2011. The limit for the 2011 SEP-IRA remains unchanged from that of 2010 because the cost-of-living index has not increased. The amount of contribution that you make is not considered as additional taxable income for the employee. Therefore, you do not show the SEP-IRA contribution as income on the employee's Form W-2.
Yet, the tax benefit is that your business is allowed an income tax deduction for the total contributions to each SEP-IRA, including the contribution that you make to your own individual SEP-IRA. The additional benefit is that, as a business owner, the SEP-IRA helps earn employee loyalty and improves retention of good staff.
As a self-employed person, you have to deduct one-half of the self-employment tax (social security tax) and contribution to your own SEP-IRA deduction from your net profit. The amount that you get would be the basis for calculating your SEP-IRA contribution.
If you are self-employed then the 2010 and 2011 SEP IRA contribution limit is 20 per cent of the adjusted earned income. The maximum you are allowed to contribute is $49,000. If you also contribute to other defined contribution plans (e.g., 401(k), IRA) then this limit is reduced accordingly. If you are an employer and are contributing an equal amount to your employees' SEP-IRA then their limit too decreases.
However, if you are the owner of an incorporated business and earn salary based on W-2 income, the contribution limit is 25% of that income. The $49,000 cap remains the same.
What is the tax rule for SEP-IRA?
The contributions are 100 per cent tax deductible and you get tax deferred growth on investments. The withdrawal is taxed as ordinary income. However, if you make withdrawals before you are 59 years and six months old then you have to pay a 10 per cent penalty. As an employer you don't have to file an IRS Form 5500.
What about employer contributions?
Only the employer makes contributions which don't have to be made every year. Neither do employees have to make payroll deducted contributions. In some cases, an employee may be allowed to make contributions to their SEP IRA as a Traditional IRA falling under the IRA contribution limits. Part time employees, who are 21 years of age who have worked 3 out of the preceding 5 years, earning $500 or more annually, must be covered by the plan which means if you contribute to the plan on your own behalf, you must do the same for any qualifying employee. Keep in mind that the previously mentioned are guidelines when the employer is required to contribute on the employee’s behalf. If the employer chooses to contribute to an employee is less than 21 years of age, it is their full discretion. An SEP-IRA helps saving for retirement and reduces your tax burden.