SEP IRA Rollover – The Right Move for the Self-Employed

The SEP IRA (short for “Simplified Employee Pension Individual Retirement Account”) has some very specific advantages and challenges for the self-employed.  In general, these types of retirement accounts are initiated by business owners in order to provide benefits for both themselves and their employees.  It is the ease of administration that makes this particular kind of account attractive for anyone who is tasked with creating a retirement account.

Usually, the administration of this type of retirement account is very straightforward.  However, there are some special considerations for the self-employed – namely, there are contribution limits you’ll need to be aware of.  In the simplest case, the contribution limit for the self-employed is just over 18.5% of annual income.

This number may change in light of two issues – when the FICA tax is taken into consideration and with a reduced rate of tax.  In the case of the FICA tax, all contribution limits are computed from net profit adjusted for the deduction for self-employed the tax.  Excluding any limits, this is half of the 15.3% FICA tax levied on the net earnings.  These net earnings are 92.35% of the net profit – all of which must be kept in mind when you do the calculations for your SEP IRA.

After the FICA taxes have been handled, you’ll need to consider the reduced rate of tax.  When it comes to SEP IRAs, there’s a 25% limit that applies to wages, not to the net profit.  This is especially important when the business is a sole proprietorship.  In this case, the employee\owner must consider his or her own wages and make an SEP IRA contribution which is limited to the 25% previously mentioned.

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Although these two issues may seem complicated, don’t let them deter you from initiating an SEP IRA rollover, as this type of financial transfer does offer several significant advantages for the self-employed.  But before you get started, be aware that there are two basic kinds of rollovers – direct and indirect SEP IRA rollovers.  An indirect rollover occurs when money from an old retirement account is placed directly into the account holder’s hands, either by check or money transfer.

Be very careful with indirect SEP IRA rollovers.  If the money comes into your hands – even if you have every intention of placing it back into a qualified retirement account – you run the risk of incurring taxes and penalties.  Remember, the IRS has no sense of humor.  If the money stays in your hands for one day longer than the 60 day window given to redeposit funds, they’ll classify the transaction as a cash withdrawal, triggering a number of taxes and penalties. In general, it just makes more sense to perform a direct SEP IRA rollover whenever you’re moving money into or out of SEP IRA accounts.

Fortunately, it’s very easy to perform a direct SEP IRA rollover.  All you have to do is contact the manager of the account you want the money moved into and tell him or her that you’d like to initiate a direct rollover from your old IRA.  Always be sure to use that exact term – “direct rollover.”  This begins a legally defined process wherein your money will be sent directly from one account manager to the other, without ever entering your hands.  And if it never comes into your hands, the IRS won’t consider your SEP IRA a taxable event and the tax-deferred status of your money will be maintained.

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