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Simplified Employee Pension IRA (SEP-IRA)

Simplified Employee Pension IRA (SEP-IRA) Plans
A SEP-IRA is a retirement plan where the employer, not the employee, generally makes the contributions. SEP-IRAs are geared to smaller businesses including sole proprietorships, partnerships and corporations as well as self-employed persons.

In many ways, the general rules for a SEP-IRA and a traditional IRA are similar. Although contributions are usually made by the employer and not by employees, employees may make optional contributions to certain pre-1997 SEP-IRAs.

Employer contributions are made with pre-tax dollars and are income tax-deductible for the employer (up to certain limits). For income tax purposes, employer contributions are not considered salary for employees. So, if you are an employee, the contributions by your employer are excluded from your income but not are deducted from it. If you are self-employed (a sole proprietor or partner), you take a deduction for employer contributions to your SEP-IRA on your federal income tax form. Special contribution rules apply when there are highly compensated employees.

The contributions and earnings in a SEP-IRA grow tax-deferred (tax isn't due until distributions).

As an alternative to the SEP-IRA, a special kind of 401K Plan (the Individual 401K) is available for self-employed individuals and their spouses. These generally allow for much greater contributions that the often uses SEP-IRA and offer additional benefits like borrowing against the value (for any purpose including real estate, college funding, etc.) and are both low cost and low administration intensive.

The general tax rules described below are the federal income tax rules as of January 1, 2001) and may be subject to exceptions. Always check your state (and local) income tax rules on SEP-IRAs. Finally, since tax laws may (and probably will) change from time to time, always check with your tax advisor before making major decisions regarding your IRAs.
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As a general rule, if any SEP-IRA contributions are made, they must be made for all employees who:

1. are at least age 21 and
2. have worked for the employer in at least 3 of the last 5 years and
3. received at least a minimum amount of compensation (e.g., $450 for 2001)
Employers can include more employees by reducing these requirements.

Contribution Limits
There are two sets of rules to determine the maximum employer contribution:
1. the general rule and
2. the self-employed rule
The General Rule
The yearly contributions by an employer to a SEP-IRA are excluded from an employee's gross income to the extent the contributions are not larger than the lesser of:
1. 15% of an employee's compensation or
2. $35,000 whichever is less
If the contributions exceed this limit, then the employee is generally taxed on the excess amount (a penalty may be charged, too).

The contribution upper limit per employee will be less than $35,000 for some time. In 2001 , it is 15% of $170,000 or $25,500.

The Self-Employed Rule
Self-employed persons can deduct contributions on their own behalf up to the lesser of:
1. 13.04% of net earnings or
2. $35,000
There are special rules defining what "net earnings" means for a self-employed person.

You are always 100% vested with a SEP-IRA.

Benefits of the SEP-IRA
1. Contributions for an employee can be up to $25,500 in the year 2001
2. Contributions aren't considered part of an employee's salary for income tax purposes and the employer can get an income tax deduction for contributions
3. Earnings and contributions grow tax-deferred without any reduction for income tax each year
4. Contributions and earnings are 100% vested
5. Special creditor protection may be available
6. It may be the simplest type of retirement plan an employer can maintain and it requires a minimum of paperwork
Negatives of the SEP-IRA
1. Distributions of earnings and employer and pre-tax employee contributions are taxed at ordinary income tax rates (from 15% to 39.6% for federal tax plus state tax as of January 1, 2001)
2. Distributions must start by April 1 of the year after you reach age 70
3. The employer decides how much or how little to contribute each year
4. You can't borrow from a SEP-IRA
Beneficiary Designations
Legal and tax advice is useful when determining how to complete beneficiary designations. Properly completed designations can help save estate (death) tax, avoid probate, allow better income tax opportunities and avoid creditor claims on retirement assets.

Extra care needs to be taken in naming trusts as a beneficiary of most retirement assets in case of a death. Sometimes, naming trusts as a beneficiary can trigger income tax sooner than it would otherwise be owed and reduce the amount ultimately shielded from death tax.

Note that many plans require the participant's spouse to be the beneficiary, unless the spouse provides written permission for another beneficieary to be named.

Creditor Protection
Retirement plans and accounts may have special creditor protection under federal and/or state laws. Different types of plans and accounts may have varying degrees of protection. State protection rules may also vary from state to state.

If you convert from one type of plan to another (e.g., from a traditional IRA to a Roth IRA), you may be changing how much protection you have. This may be also be the case if you move to another new state where the new state rules are different.

Consulting with an attorney for guidance on the creditor protection issue may be helpful.

Estate and Death Taxes
Retirement assets are added to your other assets and may be subject to federal and/or state death (estate) tax. It depends upon the size of your overall estate and the estate planning done for you. Consult with your advisor about ways to defer or avoid estate tax.

For more information:
If you'd like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.

This page (formatted for versions 10.0 and higher of Internet Explorer) is updated regularly so check in from time-to-time to see new articles and updates. You can click on any underlined words on each page to see a specific wealth management topic in the left margin of each page.

Charles M. Bloom, Registered Principal offers securities and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.

The information contained in this web site is neither an offer nor solicitation of any security or service.


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