Funding a SEP IRA

Tuesday, September 25, 2012

By Joe Cicchinelli, IRA Technical Expert

Follow Me on Twitter: @JoeCiccEdSlott

If your employer offers a SEP (Simplified Employee Pension) plan, it’s very similar to a profit sharing plan, except that contributions are placed into your designated SEP IRA. Once the funds are in your IRA, you own and control your own money. Your employer does not control the money after it’s been deposited in your SEP IRA.

In a SEP, your employer must make contributions for each eligible employee. The maximum SEP contribution for 2011 is the smaller of 25% of the individual’s compensation or $49,000. For 2012, it’s the smaller of 25% of compensation or $50,000. But the definition of compensation varies depending on whether you are an employee or the business owner.

If you are an employee, your employer usually uses IRS Form W-2, Wage and Tax Statement, as the definition of compensation. So if you work for a company that has a SEP and your annual salary is $70,000, if your employer makes a SEP contribution for the year of 10% of salary, your SEP IRA will receive a $7,000 SEP contribution (i.e., $70,000 X 10%).

If you own the business and you are self-employed, your compensation is different. A self-employed business is defined a business that is not incorporated, such as a a sole proprietor or a partner in partnership. A self-employed person does not receive a Form W-2 statement. Your compensation is generally the profit from your business with some adjustments. These adjustments can be found in IRS Publication 560, Retirement Plans for Small Business, and are typically handled by your CPA.

If you are the owner of an S Corporation, your compensation is your salary as shown on your IRS Form W-2. Any profit income passed through to you is not considered compensation for purposes of funding a SEP. It’s considered dividend income, not compensation.

Lastly, only the first $245,000 of your compensation is considered for 2011 (or $250,000 for 2012). So for example, if your compensation for 2012 is $300,000 and the employer makes a 10% SEP contribution, your IRA will receive a $25,000 contribution (i.e., $250,000 X 10%).

Article Highlights

  • Funding a SEP is based on your compensation
  • Compensation for SEPs differs if you are self-employed or own an S Corp.
  • Maximum SEP contribution for 2012 is $50,000
  • Only the first $250,000 of your compensation is considered for a SEP contribution

 

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