SEP IRA

Archive for December, 2007

Question: I want to make an early withdrawal from my SEP-IRA. What can I expect in penalties & taxes?

I spoke to my financial advisor about withdrawing money early from my SEP, but I’m confused. I assumed that if I wanted to withdraw $12,000-$13,000, then I would get that amount “cash-in-hand”. I would then have to pay the 10% withdrawal penalty and income tax (I’d get Form 1099-R) next year during tax time.

However, my advisor is telling me in order to get $12,800 “cash-in-hand”, I’d have to take out $16,000. He said 20% (10% for the penalty and 10% for taxes) has to be taken out of $16,000 in order to get $12,800. I don’t understand – I thought the penalty and taxes were assessed when I file my taxes, not when I withdraw the money. Help!

Answer: The law requires the custodian to withhold 20% for taxes. This is exactly like the taxes withheld from your paycheck by your employer. In most cases even that is NOT enough if you are taking an early distribution.

The distribution is taxed as ordinary income. If you are under age 59 1/2 there is a 10% penalty on top of the tax in most cases. (There are some exceptions such as for medical expenses or to purchase a first home, etc.) If you are in a 15% tax bracket, the total will be 25% with the penalty so the 20% withheld would not be enough. And if you were in a 25% tax bracket, you’d be short by 15% at filing time and would need to make an estimated payment of that amount immediately on that large of a distribution to avoid any chance of penalties and interest for underpayment of tax when you do file. That means you’d need to pull $20k to have $13k net of taxes.

401k Rollover Don’t Leave It Behind

Salary Reduction Agreement: The employer completes part of the form. Each employee receives a copy, and completes the remaining portion of the form, and returns it to the employer. Eligible employees use this form to advise the employer of their rate of elective deferrals or to stop their elective deferrals.

SIMPLE IRA Plan Summary: The employer completes part of the form only. This form provides general information regarding SIMPLE IRA Plans to employees.

Step 2: The employer provides copies to employees at the start of each election period. For existing SIMPLE IRA Plans, the election period is the 60-day period immediately preceding January 1 of the calendar year (November 2 to December 31 of the preceding calendar year).

Example: XYZ Company establishes a SIMPLE IRA plan, effective October 1, 2004. The employer notifies employees regarding the 2004 plan year by providing copies of Appendices A, B and C to employees on or before October 1, 2004. The employer must then notify employees on or before November 2, 2004 for the 2005 plan year and by every November 2 thereafter.

Step 3: An employee (including the business owner if he or she is also an employee) who wants to participate in the plan must complete the Salary Reduction Agreement and return it to the employer. Additionally, the employee must complete a SIMPLE IRA Adoption Agreement, which is found in the SIMPLE IRA Employee IRA Agreement.

Note: Under most SIMPLE IRA document, an employee may elect to establish a SIMPLE IRA Account at another firm that will accept the account. The employer must send monthly salary deferral checks to each financial institution where his or her employees have established their SIMPLE IRA accounts.

Step 4: Each month the employer will send the Financial Institution one check for all of the employees’ salary deferrals for the month. The employer should include a Participant Account Contribution Sheet, specifying the participant allocation of the check.

To establish a SIMPLE IRA, a business must follow SIMPLE IRA regulations and rules. This section of SEP IRA & SIMPLE IRA website is dedicated to SIMPLE IRA regulations, compliance SIMPLE IRA Rules and guidelines. SIMPLE IRA Rules can be complicated so you should become familiar with all the SIMPLE IRA regulations before you start contributing to your SIMPLE IRA. There are also different rules governing SIMPLE IRA limit or SIMPLE IRA Contribution Limits within SIMPLE IRA Plans.

Since there are many layers of SIMPLE IRA Compliance, not many people understand how SIMPLE IRA Plans work so not many businesses establish SIMPLE IRA Plans. SIMPLE IRA Compliance and Simple Ira Rules are a little more complex than SEP IRA Rules and other IRA rules. However, Simple Ira Rules can work to the Simple Ira Plan owners in many cases.

How to establish a Simple Ira Plan? What are the steps required to establish a Simple Ira Plan?

Before we discuss how to establish a Simple Ira Plan to meet SIMPLE IRA Compliance, let’s make sure that we know that all SIMPLE IRA Plans must be maintained on a calendar year basis regardless of whether the employer uses a different tax year (i.e. fiscal year). Additionally, an employer cannot establish a Simple Ira Plan if the employer maintains any other type of retirement plan for the business.

The following steps are required to set up a Simple Ira Plan.

Step 1: Complete the required SIMPLE IRA documents.

Employer Agreement: To establish a Simple Ira Plan, the employer completes and signs the Employer Agreement and the required notices to employees, which are found in the SIMPLE Employer IRA Agreement. The completed booklet should be kept in the business’ files and is not required to be sent back to Financial Institution.

Notice to Employees : The employer completes “Name of Employer” and “Address of Employer”. This section provides the specific rules the employer chooses from the Employer Agreement (i.e., Eligibility Requirements, mid-year change dates for deferral elections, employer contributions, etc.) to employees.