Many workers have access to retirement plans at work. Although the 401(k) is the most popular, some employers use a simpler option known as the Simplified Employee Pension, or SEP. With this method, workers have SEP IRA accounts established in their name. If you're fortunate enough to have a SEP IRA, it's essential to know how to manage it properly when you leave your job or retire. Let's take a closer look at how SEP IRAs work and what you should consider when it comes time to cash them in.
How an SEP IRA works
An SEP IRA is a lot easier to understand than a 401(k) plan or other retirement plan for one simple reason: It doesn't require the worker to make any contributions. Only the employer contributes to an SEP IRA, and the rules are designed to treat all qualified employees equally. If you meet the eligibility rules for the plan, then you'll be entitled to receive employer contributions into your SEP IRA. These rules typically require you to be 21 or older, work for your employer in three of the past five years, and earn at least $600 in compensation.
Unlike some retirement plans, you immediately vest in the contributions your employer makes to your SEP IRA. That means that you won't forfeit your SEP IRA balance, regardless of how long you stay at your job or when your employer made contributions to your SEP IRA.
Smart options for moving your SEP IRA
When you switch jobs or retire, then you have several options for dealing with your SEP IRA. The SEP IRA is treated just as any other IRA for distribution purposes, so you have a full range of options.
If you cash in your balance, then the full amount will be taxed at your current rate in the year in which you take the money out. If you haven't yet reached age 59 1/2, then you'll also face a 10% penalty for early withdrawal on top of the regular tax liability unless you qualify for a penalty exception.
Alternatively, you have a couple of choices that can help you avoid taxes and penalties. First, you can arrange a direct transfer to a separate IRA. That account can either already exist or be one that you establish specifically to receive the SEP IRA funds. With a direct transfer, the money will move directly from institution to institution, and you won't have to deal with tax withholding or other complications.
You can also choose to do a rollover to another IRA. This involves actually taking possession of your SEP IRA money and then redepositing it into a different IRA. There are several rules that make this method more complicated than the direct rollover. The two most important are that you have to complete the rollover within 60 days or else it will be treated as a taxable distribution, and you might also have part of your rollover withheld for tax purposes -- withholding that you'll have to make up out of your own pocket when you redeposit the money into the new IRA.
An SEP IRA gives you the same flexibility as most other types of IRAs. Although cashing in your SEP IRA is an option, alternatives like a transfer to a new IRA are usually more tax-efficient and save you money.
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