2012 and 2013 SEP IRA Contribution Limits and Eligibility Rules

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[Updated for 2013 limits]  A year or so after starting my small business and completing my first annual tax return my accountant advised that I start looking into a retirement account/plan for my business in order to lower my overall tax bill and also effectively set aside some of my business profits towards retirement. After doing my research I found that if you’re a one person employee/owner business or a small employer with only a handful of employees, a SEP IRA is the best option because it is relatively easy to setup and administer. Further, I am able to have both the SEP IRA and 401K that I get from my day-job without any adverse tax impacts. Here are some more details and rules around SEP IRA plans.

What is a Simplified Employee Pension (SEP) or Retirement plan?


A SEP is a popular and widely used retirement plan management approach because it provides self employed owners or small business owners with a few staff a simplified method to make contributions toward their employees’ retirement and, if self-employed, their own retirement. Contributions are made directly to an Individual Retirement Account or Annuity set up for each employee (a SEP-IRA). Various brokers provide IRA accounts for small business’. Contributions can be made to a SEP IRA with self employment income even if you participate in a 401k, 403b, or 457 or other retirement plan.


Who is Eligible?


Any employer can establish a SEP and is independent of company/incorporate type. However the tax advantages and administrative costs can vary based on incorporation rules. An eligible employee for a SEP IRA is one who meets the following requirements:


* attained age 21;

* has worked for the employer in at least 3 of the last 5 years;

* has received at least $550 in compensation over the last two years from the employer for each year


Contributions to a SEP IRA are generally 100% tax deductible and investment earnings in a SEP IRA grow taxed deferred. Withdrawals after age 59 1/2 are taxed as ordinary income. Withdrawals prior to age 59 1/2 may incur a 10% IRS penalty as well as income taxes.


How much may be contributed to a SEP?

For 2013, the annual contributions an employer makes to an employee’s SEP-IRA cannot exceed the lesser of:

  • 25% of compensation, or
  • $51,000  (a $1,000 increase)
  • Up to $255,000 (a $5,000 increaseof an employee’s compensation may be considered. The minimum compensation amount remains the same at $550

2012 annual contributions an employer makes to an employee’s SEP-IRA cannot exceed the lesser of:

  • 25% of compensation or $50,000
  • Up to $250,000 of an employee’s compensation may be considered as eligible for an IRA contribution

The same limits on contributions made to employees’ SEP-IRAs also apply to contributions made to a self-employed individual’s SEP-IRA.  Contributions must be made in cash (no stock). The contribution deadline is usually April 15 of the following year — i.e., you have up to April 15, to contribute for the past year’s SEP IRA.

Can catch-up contributions be made to a SEP?

Generally No. SEPs are funded by employer contributions only. However, catch-up contributions can be made to the IRAs that hold the SEP contributions if the SEP-IRA documents allow.

What if the Employee already contributes to another 401K or IRA Plan?

You are eligible to contribute to a SEP IRA even if you are already covered by a retirement plan at your full-time job or have retirement plans from other employment sources. However the lower 401K or IRA limits are still applicable to these kinds of plans. In determining this limit, contributions for employees to all defined contribution plans of the employer, which includes SEPs, must be included. So if you contributed $10,000 to a 401k, your maximum SEP-IRA would be $39,000 or 25% of your eligible compensation,’ whichever was less. If you are self-employed, however, the definition of ‘eligible compensation’ gets more involved, the result being that the maximum percentage is 20% (not 25%). You’ll find more details in IRS Publication 560.

How is a SEP established?

A SEP is established by adopting a SEP agreement and having eligible employees establish SEP-IRAs. There are three basic steps the IRA requires in setting up a SEP, all of which must be satisfied.


- A formal written agreement must be executed. This written agreement may be satisfied by adopting an Internal Revenue Service (IRS) model SEP using Form 5305-SEP, Simplified Employee Pension – Individual Retirement Accounts Contribution Agreement (banks, insurance companies, and other qualified financial institutions have templates/prototypes to help you with this)


- Each eligible employee must be given certain information about the SEP. If the SEP was established using the Form 5305-SEP, the information must include a copy of the Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions.


- A SEP-IRA must be set up for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. The SEP-IRA is owned and controlled by the employee and the employer sends the SEP contributions to the financial institution where the SEP-IRA is maintained.


A SEP can be set up for a year as late as the due date (including extensions) of the business’s income tax return for that year. Unlike a 401k where the employer has to file a IRS Form 5500, that is not required for the SEP IRA. For any employer that has gone through this process, they realize the time and effort it takes to make sure this form is filed correctly.

SEP IRA vs 401K or Traditional IRA plan


A SEP provides high maximum contribution limits, but an Individual 401k may allow a greater contribution at the same income level. Also, for those age 50+ there isn’t an additional $5,500 catch-up contribution provision like there is with the Individual 401k. A final point to consider is IRS rules do not permit loans with a SEP IRA. A SEP IRA is the right choice if you aren’t in need of a loan and don’t anticipate needing one in the future.

However, there is no harm starting with a SEP-IRA and then converting to an Individual 401k. All that is needed to transfer retirement assets from a SEP IRA to a new Individual 401k is some minor administrative paper work.

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{ 4 comments… read them below or add one }

EsKay October 5, 2012 at 11:29 am

This comment is in response to PaddyMac’s 20% vs 25% remark.

Let us say your total revenue is 100,000. You can take a gross income of 80,000 and put 20,000 in SEP IRA. That is 20% of your revenue. However, your contribution is 25% of your gross income.

So, it is all the same thing. The percentage just depends on whether it is on total revenue or gross income.

Reply

PaddyMac July 27, 2011 at 9:04 pm

You say:
25% of compensation, or
$49,000 for 2010 and 2011. This is an increase from the previous limit of $46,000
Only up to $245,000 in 2010 and 2011 of an employee’s compensation may be considered.
“The same limits on contributions made to employees’ SEP-IRAs also apply to contributions made to a self-employed individual’s SEP-IRA.”

Er, this is NOT correct. You’re obviously new to this! 25% only refers to employees. When you are a sole proprietor (and it sounds like you are) you can only contribute 20% of your net self employment income due to some reverse logic that only the IRS could think up…

Read the IRS Pub. 560 carefully and do the worksheet for sole proprietors/employer contributions. You take your self-employment income, deduct half of your self-employment tax, then multiply the result by .20% (the 25% deduction become .20 in the Rate Table for the Self-Employed in Pub 560).

Your CPA will also be able to tell you the maximum amount that you can save each year. Also, not only can you contribute up to the tax filing date (April 15 unless you extend), but you also have until April 15 to open the SEP account. Don’t leave it until the last day though, as it may take the bank 1-2 days to move assets from your checking or savings to the new SEP account.

Reply

custov February 5, 2011 at 12:15 pm

If i have employees, as a self-employed individual do i must include them in the SEP or can i elect to only contribute to my SEP account and not to my employees even though they qualify?
Please advise

Reply

dennis January 10, 2011 at 12:18 pm

sense health insurance is deductible on the form se in 2010 how well that effect the amount that can be contributed to a sep ira for the self employed? ps the 560 pub on the irs set is a 2009 pub

Reply

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