When it comes to saving for retirement, small-business owners often prioritize solutions that allow for flexibility with low costs. One type of self-employed retirement savings account that fits this bill is the SEP IRA, or simplified employee pension plan.
SEP IRAs are simple to establish and maintain, and enable business owners to contribute to IRA retirement plan savings for themselves as well as their eligible employees. They have higher contribution limits than traditional and Roth IRAs, but fewer expenses and requirements than 401(k)s. They also allow account holders to choose how those savings get invested.
Since SEP IRAs are intended to be a retirement savings vehicle, the IRS has specific guidelines surrounding withdrawal and use of these funds.
What are the SEP IRA withdrawal rules?
There are federal rules an individual may want to consider before pulling money out of a SEP IRA. Whether there are penalties or taxes involved can depend on factors such as circumstance and age.
Withdrawal restrictions end at age 59½
Once an individual reaches age 59 ½, they can begin to withdraw money—both contributions and earnings—from an IRA penalty-free, if they choose. This includes SEP IRAs as well as other types of individual retirement accounts, like Roths and traditional IRAs. With SEP IRAs, withdrawals after age 59 ½ are counted as taxable income for that year.
Early withdrawal penalties usually apply
Any withdrawal made from an IRA before age 59½ is considered an early withdrawal, and a 10% penalty plus income tax on the withdrawn amount usually apply.
When an account holder makes an early withdrawal, that amount is added to their taxable income on Form 1040 for that tax year. The funds are subject to income tax along with the rest of the earnings for that year, based on their overall tax rate.
Additionally, the individual may be required to fill out a Form 5329. This form accounts for any extra taxes due on withdrawals in addition to standard income tax.
Penalty-free withdrawals are allowed in certain situations
IRA withdrawal rules state that funds can be withdrawn from the account as early as age 59 ½, and are required to be withdrawn starting at age 72. However, there are some exceptions that allow for early withdrawals from a SEP IRA without penalty.
- Death. If the account owner passes away, their beneficiaries can withdraw funds without meeting the age requirement.
- Disability. If the plan participant is totally and permanently disabled, they can utilize their IRA savings at an earlier age.
- Education. IRA funds can be used to pay for qualified higher education expenses.
- Homebuying. Up to $10,000 can be withdrawn from a SEP IRA without an early withdrawal penalty, as long as the funds are being used by a first-time homebuyer to purchase a primary residence.
- Medical expenses. If the plan owner incurs unreimbursed medical expenses that exceed 10% of his or her AGI for the year, they can withdraw funds from a SEP IRA to help cover the difference. SEP IRA savings can also be used to pay for health insurance premiums while the account owner is unemployed, without penalty.
- Military service. Certain distributions may not be subject to the early distribution tax if withdrawn by a qualified reservist called to active duty military service.
Loans are not allowed
Unlike 401(k) plans, IRAs do not permit loans. If the account holder needs to withdraw funds from their SEP IRA prior to age 59 ½, these withdrawals are subject to an additional 10% early distribution tax penalty, in addition to being counted as taxable income. Withdrawn funds cannot be repaid at a later date.
What are the required minimum distributions?
Once the account holder reaches the age of 72, SEP IRA distributions are required. These required minimum distributions, or RMDs, must be taken from the SEP IRA each year, beginning with the year that the account owner turns 72. These are required whether or not the individual is still working, and even if they don’t actually need access to the funds.
The required distribution amount will vary, and is calculated based on the account balance and the retiree’s age, using IRS life expectancy charts. RMDs help ensure that the retiree is able to use most of their own retirement savings during their lifetime.
Another option for meeting the RMD requirement is to make qualified charitable distributions. That means charitable donations can be made to a qualified charitable organization, with funds paid out directly from the IRA.
The bottom line
SEP IRA plans are intended to provide small-business owners and their employees with flexible retirement savings options that are relatively easy to set up with few administrative hassles. SEPs also offer higher contribution limits, than say, a traditional IRA. Upon reaching retirement age, these funds can be withdrawn and used to cover a variety of costs, including everyday retirement expenses.
Prior to reaching retirement age, these contributions and earnings can be accessed, but early withdrawals are subject to added tax penalties. Once reaching the age 72, distributions are required by the IRS—even if the funds are not needed at that time.