A SEP IRA (Simplified Employee Pension Individual Retirement Account) is a tax-deductible plan established by employers or the self-employed for their employees. This plan was intended specifically to allow small business owners to make tax-deductible contributions to their employees’ accounts.
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Although employees do not pay any taxes on their employers’ SEP contributions, if any amount is distributed, this amount, as well as any investment earnings, will be taxed,
according to Investopedia.
If an account holder is self-employed, he may contribute up to 25 percent of his net profits after they’ve been adjusted for self-employment taxes, which amounts to approximately 18.6 percent of his net profits,
according to Money Crashers. When the employee withdraws any contributions, those contributions will be taxed. The money deposited in the SEP IRA remains immune from taxes, however, until it is withdrawn from the account, just like other traditional IRAs. The employer’s 25 percent contributions must not exceed $52,000, as of 2014.
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SEP IRAs also allow for greater funding flexibility for the employer than many other IRAs because the employer is not required to contribute to the plan during a downtick in business. However, during a booming business year, the employer may contribute larger portions to employees’ accounts,
according to CNN Money.
But if the employer makes excessive contributions to employees’ accounts, those contributions are included in the employees’ income,
according to the IRS. Excess contributions left in the employees’ accounts after their federal return will incur a six percent tax, and the employer may receive 10 percent excise tax.
All in all, contributions for SEP IRAs boost deductions and lower the taxable income while allowing for the adjustments in income for the self-employed. Any investment income accumulated in the account is tax-deferred, as well.
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