A common question for self employed or business owners who run an SEP (Simplified Employee Pension) IRA is how much can an individual contribute to the plan. And given the rules surrounding it and how it relates to 401(k)'s and those that both work for a company and have an SEP IRA it is no wonder. Let's start out by defninng what an SEP IRA is. From the IRS website:

A simplified employee pension (SEP) is a written arrangement that allows your employer to make deductible contributions to a traditional IRA (a SEP IRA) set up for you to receive such contributions. Generally, distributions from SEP IRAs are subject to the withdrawal and tax rules that apply to traditional IRAs. See Publication 560 for more information about SEPs.

So what exactly does that mean? Well an SEP IRA is very similar to a traditional (pre-tax) IRA. it allows for funds to be diverted pre-tax into a retirement account that will grow tax free until withdrawal. The key difference being that the individual does not contribute to an SEP IRA, it is the employer (or business) that contributes to this IRA. In the case of a sole proprietorship or partnership these lines can be somewhat blurred, but it is still the business entity that is contributing, not the individual person. Generally speaking the SEP IRA is popular among small business owners and small partnerships. It can be applied to larger companies, but often is deferred to a 401(k) type of plan.

This is often where the rubber hits the road for most. The rules aren't exactly 1st grade math. In general the contribution limit is $49,000 in 2009 (it was $46,000 in 2008). But there are some stipulations around this. It really depends on how your company is set up, for more check out each particular type of business entity below.

If you receive income from the business entity in the form of W2 wages then the amount that can be contributed to an SEP is between 0% and 25% of the recipients W2 income up to the stated max contribution limit ($49,000 in 2009).  This is often the case with S and C Corps and to a lesser extent with LLC's and incorporated partnerships.  The key being the W2 income, not the overall income of the business (if you keep a fair stake within the company for future growth and so forth).

As is generally the case in a sole proprietorship (as well as unincorporated LLC's and partnerships) rather than W2 income one would receive personal income.  In this case the amount that may be contributed would be between 0% and 20% of your net adjusted self employment income (which is generally your gross income minus business expenses and half of the self employment taxes).  Again this is capped by the yearly maximum as described above ($49,000 in 2009).

Generally speaking an SEP IRA is a great vehicle for the self employed and small business owner along with smaller corporations like a partnership as it allows for greater contribution limits than a standard IRA or Roth IRA (if you qualify for a best Roth IRA). Just remember that the contributions are capped and that only a certain percentage of your personal or W2 income can be set aside into an SEP IRA.

->The information on this page is for informational purposes only and does not constitute, and should not be construed as, professional, legal or tax advice. To determine your individual tax situation and specific needs, please consult a professional tax advisor.

-> Information contained in these sections merely highlight some benefits. There are risks involved with all investments that could include tax penalties and risk/loss of principal.