4 SEP IRA Plan Rules That May Surprise You

By Sarah Brenner, JD
IRA Analyst
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Are you a small business owner or a sole proprietor? If so, you may use a Simplified Employee Pension (SEP) IRA plan to save for retirement. These plans are a popular choice for small businesses because they are inexpensive and easier to administer than other retirement plans. While SEPs are pretty straight forward, there are some rules that may surprise you

How a SEP Works

Contributions, which are tax-deductible for the business or individual, go into a traditional IRA established by the employee. Only the employer can make SEP contributions. Employees do not make SEP contributions. In general, salary deferrals are not permitted. One of the key advantages of a SEP IRA over a traditional or Roth IRA is the elevated contribution limit. For 2019, business owners can contribute up to 25% of income or $56,000, whichever is less.

Once in the IRA the funds are like any other IRA funds and are subject to all the rules that normally apply to IRAs. The funds immediately belong to the employee, and they can do whatever they want with them, including taking a distribution. It is not unheard of for employees to immediately take distributions as soon as the SEP contributions are made. This may not be a smart move as far as saving for retirement, but it is allowed. Distributions are taxable and will be subject to the 10% early distribution penalty if taken before age 59 ½, unless an exception applies.

4 Surprising Rules

While SEP IRA plans are designed to be easy, some of the rules may be unexpected. Here are 4 SEP IRA plan rules that could surprise you:

1. If you make a SEP IRA contribution for the year, you can still contribute to either a Roth IRA or a traditional IRA for the same year, as long as you are eligible. However, because you would be considered an active participant in an employer plan, it may prevent you from taking a tax deduction for an IRA contribution.

2. Your deadline for making employer contributions to a SEP is not the same as your IRA contribution deadline. For IRAs, the deadline is generally the tax-filing deadline, not including extensions. For SEP contributions, if you have an extension to file your business’ tax return, the SEP contribution deadline is your deadline, plus extensions.

3. A SEP contribution may be made to the same IRA to which you make your traditional IRA contribution. Under the rules, that is allowed. However, some custodians may have policies against this.

4. You are never too old for a SEP contribution. There is no age limit as long as you are working and meet the plan’s eligibility rules. You can make SEP contributions even if you are age 70 ½ or older.

5. Generally, salary deferrals are not allowed to be made under the SEP IRA plan. If you are doing this, you usually have a problem. However, there is a type of SEP called a Salary Reduction SEP Agreement (SAR-SEP). New SAR-SEPs were not allowed to be established after 1996, but those already in existence were permitted to continue. If this rare exception applies to you, you can continue to make salary deferrals to your SAR-SEP IRA.