- SEP IRA contributions are tax-deferred, so taxes are only paid when distributions are taken.
- Distributions taken before the age of 59 ½ may be subject to an early-withdrawal penalty.
- Required minimum distributions must be taken at the age of 70 ½.
Highly qualified professionals have their pick of potential employers, and they tend to choose companies that show a commitment to employees. While more complicated corporate retirement programs are often too expensive for small or medium-sized businesses, employers still have an opportunity to contribute to employees’ retirement savings through a Simplified Employee Pension Plan Individual Retirement Account (SEP IRA). Since SEP IRA distribution rules permit account holders to withdraw funds at any time, staff members have the added benefit of more flexibility in case of a financial emergency.
Understanding the SEP IRA
The SEP IRA is similar to a Traditional IRA in that contributions and earnings are tax-deferred. No taxes are paid until employees withdraw from the account, which is typically after retirement, when participants find themselves in a lower tax bracket than during periods of employment. The primary difference between a Traditional IRA and a SEP IRA is that contributions to the SEP IRA are made exclusively by the employer. Employees benefit by growing their wealth tax-deferred, and employers benefit by receiving a tax deduction for contributions made to employee accounts.
SEP IRA Withdrawal Rules
Participants can withdraw funds from their SEP IRA at any time without being required to show evidence of financial hardship. However, withdrawals taken before the age of 59 ½ –referred to as early distributions – may be subject to a 10% tax penalty in addition to the applicable income tax liability. There are a number of situations where the penalty may be waived, including the following:
- Death of the accountholder
- Certain higher education expenses
- A series of substantially equal payments
- Up to $10,000 for first-time home buyers
- As a result of an IRS tax levy
- Certain qualified unreimbursed medical expenses
- Health insurance premiums while unemployed
- Qualifying situations in which a military reservist is called for active duty
If any of these exceptions apply, distributions taken before the age of 59 ½ are still subject to income tax, but accountholders are not responsible for the additional 10% penalty.
Required Minimum Distributions
Because contributions to SEP IRAs are tax-deferred, the IRS put rules in place to ensure that funds are eventually withdrawn from the protected account. When participants reach the age of 70 ½, they must begin taking required minimum distributions (RMD). The amount of the RMD is calculated based on life expectancy, and the IRS offers a number of helpful tools to ensure that you withdraw the correct amount.
Compliance with this regulation is critical as the tax penalty for failure to withdraw the RMD is 50% of the amount that should have been distributed. Note that RMDs are required for all participants when they reach the age of 70 ½, even if they are still employed and receiving employer contributions.
While the SEP IRA is intended to provide financial security in retirement, it comes with the added benefit of flexibility in making withdrawals at any time and for any reason, although an early withdrawal penalty may apply. When withdrawals are made after the age of 59 ½, accountholders are only responsible for standard income taxes. These rules make the SEP IRA a popular choice among employer-sponsored retirement plans.
Nothing in this article should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. This article is not intended as investment advice, and Wealthfront does not represent in any manner that the circumstances described herein will result in any particular outcome. Financial advisory services are only provided to investors who become Wealthfront clients.
This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.