IRAs and SEPs

There are often questions about what kind of an investment account a taxpayer should consider. There are several that this document will discuss:

Traditional Ira
Roth IRA
SEP

Below is a comparison chart that may help you become familiar with the differences.

Comparison Table of Self Employed and Small
Business Retirement Plans

	Individual 401k	SEP IRA	Defined Benefit Plans	Simple IRA
Who is Eligible for this Retirement Plan?	Self employed individuals with no employees other than a spouse Sole Proprietors, LLCs, Partnerships, S and C Corporations	Self employed individuals with no employees or small businesses with employees Sole Proprietors, LLCs, Partnerships, S and C Corporations	Self employed individuals or small businesses owners with 4 or fewer full time employees Sole Proprietors, LLCs, Partnerships, S and C Corporations	Companies with 100 or fewer employees Sole Proprietors, LLCs, Partnerships, S and C Corporations
Key Retirement Plan Features	Provides benefits similar to a traditional 401(k) with less administration. May permit greater contributions than SEP-IRA, SIMPLE IRA or profit sharing plan without the rigid funding requirement of a Defined Benefit Plan	Easy to administer, low-cost No IRS reporting required No annual funding required Employer must contribute to eligible employee accounts in any year that the plan is funded	Provides the maximum allowable tax deductible retirement plan contribution.	Easy to administer, low-cost No IRS reporting required Largely funded by employee contributions, but limited employer contribution required
Employee Contributions	Salary deferrals up to 100% of compensation up to $15,500 or $20,500 if age 50+ in 2008	None	None	Up to 100% of compensation up to $10,500 or $13,000 if age 50+ in 2008
Employer Contributions	Profit sharing contributions up to 25% of compensation. In 2008, employer and employee contributions have a combined maximum of $46,000 or $51,000 if age 50+	100% employer funded Up to 25% of compensation with a maximum of $46,000 in 2008	100% employer funded The annual contribution is calculated annually by an actuary Defined benefit plans provide the maximum allowable tax deductible retirement plan contribution	Employer's have a mandatory match and must select from 1 of 2 matching formulas Match employee contributions dollar for dollar up to 3% (up to a maximum of $10,500 or $13,000 if age 50+ in 2008) A 2% match of employee compensation to all eligible employees regardless if the employee is electing to defer a portion of their salary or not (up to $4600 in 2008)
Required Administrative Filings and Responsibilities	Must file IRS Form 5500 when plan assets are greater than $250,000	No employer tax filings	Annually an actuary makes calculations to determine the amount that needs to be contributed into the plan to ensure the target retirement income goal is reached	No employer tax filings
Loan and Withdrawal Information	Tax free loans are permitted. 50% of the total 401k value can be borrowed up to a maximum of $50,000.	Withdrawals prior to age 59 1/2 are permitted, but may be subject to a 10% penalty plus income taxes	Hardship withdrawals are not permitted Loans are available if this feature is elected when the plan is adopted Receiving a loan may increase the annual required contribution	Withdrawals prior to age 59 1/2 are permitted, but may be subject to a 25% penalty if taken within the first 2 years of participating in a SIMPLE IRA. Also, an additional 10% penalty may apply for withdrawals prior to age 59 1/2 in addition to ordinary income taxes
Setup Deadlines	December 31st or fiscal year end	Personal tax filing deadline if a sole proprietor plus extensions or the business tax filing deadline if incorporated plus extensions	Must be set up by December 31st or fiscal year end	Must be established by October 1st

One of the biggest differences between the Traditional and Roth IRA relates to the tax treatment of principal and interest. In a traditional IRA, assume you earn $45,000 a year and invest $2,000 in your IRA. You can deduct your $2,000 contribution. You will be paying tax on $43,000 instead of $45,000. At 59 1/2, you may begin withdrawing funds, but you will have to pay tax on all of the capital gains, interest, dividends, and so forth that you earned over the past years.

By comparison, investing the same $2,000 in a Roth IRA would not give you a current income tax deduction. However, if you need any of your money that is in this account, you could withdraw the principal at any time. You will, however, pay penalties if you withdraw any of the earnings your money has made. When you reach retirement age, you can withdraw all of the money (principal and interest) 100% tax free.

The Roth IRA is usually the best choice in most situations. However, there are income limitations that will disqualify many taxpayers from using a Roth. A single taxpayer cannot make over $95,000. A married couple filing a joint return cannot make over $150,000 yearly.

There are limits as to how much you can contribute to your IRA each year.

IRA Contribution Limits

YEAR	AGE 49 & BELOW	AGE 50 & ABOVE
2002-2004	$3,000	$3,500
2005	$4,000	$4,500
2006-2007	$4,000	$5,000
2008	$5,000	$6,000

TRADITIONAL IRA

A Traditional Individual Retirement Account (or Traditional IRA for short), is a special type of account which allows investors to make tax-deductible contributions. The money can be invested in stocks, bonds, mutual funds, etc., and the earnings grow tax-free until the account's owner turns 59 1/2 years old (if money is withdrawn before this age, a 10% penalty is incurred). At this time, the account holder is allowed to begin withdrawing money from the account to fund their retirement. The distributions are fully taxed by the U.S. government. Money must be withdrawn from the account no later than the April 1 following the year the owner turns 70 1/2. The traditional IRA was essentially the only choice until the late 1990's when Congress passed the Taxpayer Relief Act of 1997, at which time the Roth IRAwas created.

The Traditional IRA has the following characteristics:

Tax deductible contributions (depending on income level)
Withdraws begin at age 59 1/2 and are mandatory by 70 1/2.
Taxes are paid on earnings when withdrawn from the IRA
Funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.)
Available to everyone; no income restrictions
All funds withdrawn (including principal contributions) before 59 1/2 are subject to a 10% penalty (subject to certain exceptions).

The exceptions for the 10% penalty are the following:

1. If the IRA owner becomes permanently disabled, money can be withdrawn without penalty.

2. If the IRA owner dies before reaching 59 1/2, his or her estate will not be hit with the 10% fee for withdrawing the money early.

3. In the event of serious illness or injury that requires prolonged or expensive medical treatment, the IRS will wave the earthly withdrawal fee if the withdrawals used to pay non-reimbursed medical expenses that are in excess of 7.5% of adjusted gross income.

4. Withdrawals that are used to help pay for first-time home purchase (cannot exceed $10,000 during lifetime of IRA owner) will not be subject to the penalty.

5. Withdrawals that are used to pay for certain higher education costs for the IRA owner or his/her family can escape the penalty.

6. Money withdrawn to pay back taxes to the IRS after a levy has been placed against the IRA will not be subject to the penalty.

7. Withdrawals are used to pay medical insurance premiums after the owner of the IRA has collected unemployment for longer than twelve weeks will not be subject to the penalty.

8. Withdrawals that "are a series of 'substantially equal period payments' made over the life expectancy of the IRA" holder" will not be subjected to the penalty.

The traditional IRA differs from a ROTH IRA in several important areas. The most significant is that you can get a current tax deduction for your contribution (with some limitations). However, if you have an employer sponsored retirement plan, such as a 401(k), your tax deduction may be limited.

In 2003, for single tax filers with an employer sponsored retirement plan, an IRA contribution was fully tax-deductible if your income was below $40,000. It is then prorated between $40,000 and $50,000. If your income was over $50,000 and you have an employer sponsored retirement plan such as a 401(k) you receive no tax deduction.

For married couples the same rules apply except the deduction is phased out between 60,000 and $70,000. The phase-out ranges are scheduled to increase over the next few years. The table below summarizes the deduction phase-out for 2003 - 2007.

Traditional IRA Deduction Income Phase-Out Ranges
Year	Single Taxpayers	Married Taxpayers Filing Jointly
2003	$40,000-$50,000	$60,000-$70,000
2004	$45,000-$55,000	$65,000-$75,000
2005	$50,000-$60,000	$70,000-$80,000
2006	$50,000-$60,000	$75,000-$85,000
2007	$50,000-$60,000	$80,000-$100,000

If your spouse has an employer sponsored retirement plan, but you do not, your tax deduction is phased out from $150,000 to $160,000. If you are married filing separately and have an employer sponsored retirement plan, the income phase-out is from $0 to $10,000.

During 2004, the maximum you could contribute to an IRA (traditional or ROTH) was $3,000. This increased to $4000 for 2005, 2006 and 2007, and to $5,000 beginning in 2008.

ROTH IRA

Roth IRAs have the following characteristics:

Contributions are not tax deductible
Contributions can be made after age 70 1/2
Contribution eligibility is not restricted by active participation in an employer's retirement plan
There is no Mandatory Distribution Age
All earnings and principal are 100% tax free if rules and regulations are followed
Funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.)
Available only to single-filers making up to $95,000 or married couples making a combined maximum of $150,000 annually.
Withdrawals upon death or disability, for first time home-buying or after age 59 ½ are tax-free provided a 5 year wait has occurred.
Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).

As noted above, Roth IRA contributions are limited for higher incomes. If your income falls in a "phase-out" range you are allowed only a prorated Roth IRA contribution. If your income exceeds the phase-out range, you do not qualify for any Roth IRA contribution. The table below summarizes the income "phase-out" ranges for Roth IRAs.

Tax filing status	Income Phase-Out Range
Married filing jointly or Head of household	$150,000 to $160,000
Single	$95,000 to $110,000
Married filing separately	$0 to $10,000

If you have more than one Roth IRA, you treat them as a "single account: when you calculate the tax consequences of making a distribution from any of the accounts. As a reminder, to be tax-free, both of the following requirements must be met:

The distribution must be made after the five (5) year holding period, and
The distribution must be made:
- on or after the individual reaches age 59 1/2, or
- made to the individual's beneficiary or estate, or
- made to the individual who has become disabled, or,
- made for a first time home purchase.

SEP

Simplified Employee Pensions, known as SEPs, represent an easy, low-cost retirement plan option for employers, without becoming involved in more complex retirement plans (such as Keoghs) Instead of establishing a separate retirement plan, in a SEP the employer makes contributions to his or her own Individual Retirement Account (IRA) and the IRAs of his or her employees, subject to certain percentages of pay and dollar limits. Employers who establish SEPs can:

Make tax deductible contributions to their own and their employees' IRAs.
Omit or reduce contributions in years when contributions are unaffordable.
Avoid the administrative costs and the reporting requirements of conventional plans

Employers can contribute a maximum of 25% of an employee's eligible compensation or $40,000, whichever is less. If the limits are exceeded, there is a non-deductible penalty tax of 6% of the excess amount contributed that will be assessed for each year in which an excess contribution remains in a SEP-IRA.

Employees are able to exclude from current income the entire SEP contribution. However, the money contributed to a SEP-IRA belongs to the employee immediately and always. This is important to employees because if they leave the company, all retirement contributions go with them (this is known as portability).

The IRS requires employers to include all eligible employees who:

are at least age 21, and
have been with a company for 3 years out of the immediately preceding 5 years.

However, employers have the option to establish less-restrictive participation requirements, if desired.

An employer is not required to make contributions in any year or to maintain a certain level of contributions to a SEP-IRA plan. This is a benefit for small employers because it will allow them to change their annual contributions based on the performance of the business.

For calendar year corporations with a March 15, 2009 tax filing deadline, SEP-IRA contributions must be made by the employer by the due date of the company’s income tax return, including extensions. The contributions are deductible for tax year 2008 as if the contributions had actually been contributed within tax year 2008.

Sole proprietors have until April 15, 2009, or to their extension deadline, to make their SEP-IRA contribution if they want a 2008 tax deduction.

The SEP-IRA enrollment process is a two page application process. The employer completes Form 5305-SEP. The employee completes the IRA investment application usually supplied by a mutual fund company or some other financial institution which will hold the funds. Nothing has to be filed with the IRS to establish the SEP-IRA or subsequently, unlike many other retirement plans that require IRS annual returns.

REQUIRED MINIMUM DISTRIBUTIONS

In a Dec. 17 letter to Rep. George Miller (D-CA), Chairman of the House Committee on Education and Labor, a Treasury official has said that IRS will not relieve retirement plan account participants and IRA owners of the need to take required minimum distributions (RMDs) for 2008. The only relief these taxpayers can look forward to is the Pension Act's waiver of the requirement to take RMDs for 2009.

As background information, an owner of a traditional IRA must start taking required minimum distributions (RMDs) from his IRA by Apr. 1 of the year following the year in which he attains age 70 1/2. (Code Sec. 408(a)(6) , Reg. § 1.408-8 ) A participant in a qualified retirement plan (e.g., 401(k) plan) must begin taking distributions by Apr. 1 of the calendar year following the later of the year in which he: (a) reaches age 70 1/2, or (b) retires (except for 5% owners, who are subject to the same rules as IRA owners). But a qualified plan may provide that the required beginning date for all employees (including non-5% owners) is Apr. 1 of the calendar year following the calendar year in which the employee attains age 70 1/2. (Reg. § 1.401(a)(9)-2, Q&A 2(e)) The RMD for each year from IRAs or individual accounts under a qualified defined contribution plan is found by dividing the account balance as of the end of the preceding year by the life expectancy factor from tables in the regs. (Reg. § 1.401(a)(9)-5, Q&A 4(a)) RMDs for a particular year (except the first RMD) must be taken by Dec. 31 of that year.

In general, designated beneficiaries of IRAs (including Roth IRAs) and retirement plan accounts also must take minimum distributions each year.

Under Code Sec. 4974, failure to take an RMD (or failure by a designated beneficiary to take the year's minimum distribution) triggers a 50% excise tax.

Note: The information contained on this page is believed accurate at the time it was prepared. It is intended to acquaint you with the various investment options and their individual characteristics.

Before making any IRA/SEP investment or withdrawal, you should contact your investment broker for advice, or ask for a personalized review of your financial situation by a tax professional and seek his or her advice on the potential benefits/consequences of making an investment or withdrawal.

Revised 12/25/2008

Comparison Table of Self Employed and Small Business Retirement Plans