Here's How You Can Withdraw From a SEP IRA Without Penalties
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A SEP IRA, or Simplified Employee Pension Individual Retirement Account, is a great tool for saving for retirement, especially if you are self-employed or working for a small business. However, it is essential to understand how to take money from a SEP IRA. Whether you are nearing retirement or dealing with unexpected expenses, understanding the withdrawal rules can help you avoid penalties and make smart financial decisions.
You Can Withdraw Anytime, But at a Cost
Unlike some retirement accounts that restrict withdrawals until a certain age or life event, a SEP IRA allows withdrawals at any time. Withdrawals made before the age of 59 and a half will be taxed as ordinary income and come with an additional 10% early withdrawal penalty.
There are, however, some exceptions to this penalty. You may be able to avoid the extra tax if your withdrawal is used for specific reasons, such as higher education expenses, a first-time home purchase (up to $10,000), certain medical bills or if you become disabled. Death and IRS levies also qualify as penalty-free triggers.
However, even if the penalty is waived, you will still owe regular income taxes on the amount you take out.
What Happens After Age 59 and a Half?
After turning 59 and a half, you can start withdrawing from your SEP IRA without the 10% penalty. At this point, withdrawals are taxed as ordinary income, with no additional fees. This is typically when retirees start dipping into their savings, often at a lower tax rate than during their working years.
If you are planning to use your SEP IRA funds to supplement retirement income, this is the age when it makes the most sense financially to begin withdrawals.
RMDs Start at Age 73
SEP IRAs come with Required Minimum Distributions (RMDs), which are mandatory yearly withdrawals you must start taking once you hit age 73. The amount is based on your life expectancy and account balance, and the IRS provides worksheets to help calculate the exact number.
If you fail to take the required amount, you could face a 50% tax on the amount you should have withdrawn.
No Loans, But Rollovers Are Allowed
One thing to keep in mind is that SEP IRAs do not allow loans. You cannot borrow against your account, nor can you use it as collateral. However, you can roll over your SEP IRA into another traditional IRA or eligible retirement plan without triggering taxes or penalties, as long as you follow IRS rollover rules.
This flexibility helps you to consolidate accounts or move to a financial institution with better investment options.
What About Contributions?
Unlike other IRAs, you cannot make your contributions to a SEP IRA if you are an employee. Only an employer or a self-employed individual can make a contribution.
Contribution limits are much higher than traditional or Roth IRAs, going up to $69,000 in 2024 or 25% of compensation, whichever is less.
The employer also gets to decide how much to contribute each year, and they do not have to make contributions annually. But if they do contribute, they must do so at the same percentage rate for all eligible employees.
Once your employer contributes to your SEP IRA, the money is entirely yours immediately.
Timing & Taxes Matter
All SEP IRA withdrawals are taxed as ordinary income in the year you take them. That includes employer contributions and any investment earnings. Thus, to manage taxes, it is better to plan your withdrawals around your income bracket, especially once you are in retirement and likely earning less than you did during your working years.
The Bottom Line
SEP IRAs offer a lot of flexibility and high contribution limits, which makes them a solid retirement savings tool. But like any retirement account, understanding the withdrawal rules is key to maximizing your money and avoiding costly mistakes.
If you are unsure about how a withdrawal will affect your taxes or whether you qualify for an exception to the penalty, talk to a financial advisor or tax professional before making any decisions.