Function

• A SEP IRA is a Simplified Employee Pension Individual Retirement Account. Used in the United States, businesses can provide this form of retirement account to employees and owners, provided the same benefits are standardized throughout the organization. Funds are subject to the same regulation and rules as regular IRAs. However, a SEP IRA is a substantial tool for self-employed individuals in that the administrative costs are low.
  
  

Features

• The only specifications that can be applied to employees interested in a SEP IRA account are that an employee must be twenty-one years of age, has worked for the employee for three years, and receives at least $500 in compensation. Contributions to the plan are deductible in the current tax year, however, ordinary tax rates apply when withdrawals are make after the age of fifty-nine.
  
  

Significance

• Contributions to a SEP IRA are treated as if they are part of profit-sharing plan. Employees can apply no more than twenty-five percent of their pre-tax wages into the SEP IRA. The maximum amount that is allowed to be placed into an SEP IRA is $46,000 as of 2008, even if that amount is less than twenty-five percent of their wages. This limits the amount of money that can be used for retirement in an IRA.
  
  

Considerations

• Self-employed persons have a more complicated set of rules regarding SEP IRAs. The limit on what a person can include is set at eighteen-point-six percent of their net profit adjusted for the deduction of self-employment tax. Because FICA tax is levied on net earnings, adjusted net profit must deduct the self-employment tax before making a contribution. However, when a business is a sole proprietorship, the employee/owner can pay themselves a wage that will allow a full twenty-five percent to be deducted and placed into the SEP IRA.
  
  

Misconceptions

• One of the greatest mistakes an individual or employee make when contributing to a SEP IRA is to not hold that money until they reach the age of fifty-nine. Individuals that retire early often make withdrawals from their SEP IRA before that age and suffer penalties for early removal of funds.
  Also, financial problems before that age prompt many people to close out their accounts to pay for necessities. This creates a situation in which the individual pays a penalty for early withdrawal in addition to the income tax at the current rate.