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If you’re interested in depositing much, much more into an IRA than the traditional $5,000 annual limit, an SEP IRA may be just the ticket. The catch? You’ll have to start your own business (read 26 Ways to Make Extra Money Wile Keeping Your Day Job).
Simplified Employee Pension Individual Retirement Accounts, known as SEP IRAs, are IRAs that business owners can set up and fund on behalf of employees and/or themselves, even if there’s only one employee … YOU! And the annual contribution limit for 2011? Almost ten times the regular IRA contribution limit! One key difference is that instead of the employees, it’s the employers that make contributions to the plan. Last year, corporations were able to make a contribution of the lower of $49,000 or 25% of an employee’s compensation, so if you want to get started making much larger contributions to YOUR retirement account, get your corporation started with LegalZoom ASAP and get your business off the ground.
SEP IRAs are most often used by:
- Self-employed sole proprietors who don’t otherwise have access to employer-sponsored plans, such as 401(k)s, for their own retirement investing purposes
- Small-business owners who want to offer a basic retirement plan to employees and/or themselves without the complexity and expense of setting up a 401(k) plan
The Advantages of SEP IRAs
SEP IRAs have four main advantages:
- Higher contributions: If you’re an employer, SEP IRAs let you contribute up to 25% of your eligible annual income (and that of your employees), up to $49,000 per year (for 2011), whichever number is lower. Future limits will be inflation adjusted. These limits vastly exceed those of IRAs and allow self-employed people to contribute as much as the maximum annual 401(k) contribution. SEPs don’t allow catch-up contributions, however.
- Higher deductions: SEP IRA contributions are usually 100% tax deductible (check with a tax advisor first), which means you can take up to a $49,000 tax deduction annually—much more than the $5,000 deduction for Traditional IRAs.
- Tax deferred growth: SEP IRA contributions grow tax deferred until withdrawal.
- Multiple plans: You can create SEP IRAs even if you also have another IRA. Likewise, you can set up a SEP even if you already have an employer-sponsored plan, such as a 401(k), as long as the income you use to contribute to the SEP IRA comes from a separate source (hence the need to start another business). SEP IRAs are a great option if you have an employer-sponsored plan but also earn income on the side by running your own business.
How SEP IRAs Work
SEP IRAs for self-employed sole proprietors work a bit differently from SEP IRAs for employers.
- If you’re a self-employed sole proprietor: You set up an account with a financial services firm such as Scottrade and make contributions up to certain annual limits, just as you would with a Roth or Traditional IRA.
- If you’re an employer: You set up SEP IRA accounts with a financial services firm for yourself and your employees. Employees do not set up or administer their own accounts. By law, as an employer you’re required to contribute the same percentage of income into your employees’ accounts as they contribute into their own accounts each year (up to the stated limits). Employees cannot make contributions on their own but can roll over their accounts into Rollover IRAs if or when they leave the company.
Regardless of whether you’re a sole proprietor or an employer, there are a lot of rules surrounding the use of SEP IRAs so be sure and check out the IRS web page on SEP IRAs and consult with a qualified financial advisor to ensure you’ve dotted your i’s and crossed your t’s.