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SEP-IRAs - An Important Self-Employed Retirement Plan Option

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By Michael Rubin. Retirement Planning Expert

A SEP-IRA (Simplified Employee Pension) allows employers to make retirement plan contributions to its employees. In addition, self-employed individuals may create and fund a SEP-IRA retirement plan for themselves. Compared to the better-known 401(k) plan. potentially higher contribution limits along with far less complexity are key SEP-IRA benefits.

Who Can Set Up a SEP-IRA?

An individual with earnings from self-employment may create a SEP-IRA, even if he is also an employee elsewhere covered by a workplace retirement plan.

Benefits of a SEP-IRA

In addition to the SEP-IRAs primary benefit as an easy-to-implement retirement savings vehicle, a SEP-IRA can also provide large tax benefits. Contributions to a SEP-IRA provide a tax deduction to the employer (or self-employed individual ) for the tax year to which the contributions are designated.

SEP-IRAs lack an annual IRS filing requirement.

As further evidence of their simplicity, the paperwork necessary to establish a SEP-IRA is minimal.

Important SEP-IRA Dates

Like regular IRAs and Roth IRAs. contributions to a SEP-IRA can be made following the year to which the contribution applies. In addition, the ordinary SEP-IRA contribution deadline can be extended to as late as the extended due date of the tax return.

The deadline for creating the SEP-IRA is also the due date of the tax return plus any extensions. For most people, the SEP-IRA must be established and the contributions made by the April

15 following the year the income was earned.

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Furthermore, most taxpayers may extend their tax returns to as late as October 15 and thereby also receive an extension of time to create and fund their SEP-IRAs.

SEP-IRA Contribution Rules

There is a great deal of flexibility in the amount you contribute to your SEP-IRA. There is very little flexibility in who you contribute it to.

Since the contribution amount can be determined annually, there is no obligation for an annual contribution of a certain amount or percentage. In any year, the contribution amount can be as little as 0% to as much as 25% of compensation, provided that the total contribution to any one individual does not exceed $46,000 for 2008 ($49,000 for 2009).

Note: The employer must contribute the same contribution percentage to every employee who is at least 21 years old, earned $500 or more for the year in question, and worked for the employer at least three of the previous five years.

Compensation Calculation

Self-employed individuals who wish to calculate and possibly fund the maximum allowable SEP-IRA contribution should prepare for some head-scratching. First, the previously mentioned 25% limit is on net profit. not gross revenue. More importantly, the deduction for half of the self-employment tax as well as the deduction for the SEP-IRA contribution itself must be subtracted from the net profit number for purposes of calculating the SEP-IRA limit.

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