SEP IRA Withdrawal

For small businesses, Simplified Employee Pensions (SEPs) represent a flexible, easy-to-administer method of providing retirement benefits to their employees. Because contributions to these plans are tax-deferred until distribution, SEP accounts are subject to IRS rules regarding how, when, and for what purposes a SEP IRA distribution may be made. SEP IRA withdrawal rules are designed to protect and preserve the funds in the SEP account for their intended purpose of financing retirement; for this reason, only a few exceptions exist to allow early withdrawal of an SEP IRA distribution.

SEP IRA distribution during retirement


Typically, the first SEP IRA distribution takes place upon retirement, sometime after the participant reaches the age of 59 and 1/2 years. Account holders are required to accept minimum withdrawals as prescribed by IRS regulations in the year they reach the age of 70 and 1/2 years; these are known as required minimum distributions. Failure to withdraw required minimum distributions can lead to the imposition of an excess accumulation penalty amounting to 50% of the due but undistributed portion of the SEP account. Thus, it is essential from a financial standpoint that SEP distributions be scheduled and distributed in accordance with the schedule outlined in the SEP IRA withdrawal rules of the IRS.

SEP IRA withdrawal before retirement


The SEP IRA withdrawal rules place restrictions on and assess penalties for withdrawals from SEP accounts that occur prior to the age of 59 and 1/2. SEP plans are funded through traditional IRA accounts; as a result, the rules for SEPs are very similar to those of traditional IRAs. Early withdrawals typically incur a 10% penalty; this is in addition to any taxes already due on the amount, which is charged at the participant’s normal rate. Certain exceptions exist that can allow SEP account holders to make withdrawals without incurring this additional penalty; these exceptions are intended to provide financing for major life events and extreme circumstances. The funds in an SEP plan are intended to finance retirement; withdrawals reduce the amount available for this intended use.

SEP IRA distribution exceptions


IRS regulations provide for certain exceptions to the general SEP IRA distribution rules. These exceptions can allow SEP participants to withdraw a portion of their accrued SEP fund without incurring the 10% IRS penalty for withdrawals before the participant reaches the age of 59 and 1/2; normal tax rates will still apply to these withdrawals. These exceptions include:
  • Death or disability of the plan participant
  • Medical insurance premiums for periods of unemployment
  • Post-secondary educational expenses
  • Purchase of a first home
  • Payment of IRS levies
  • Unreimbursed medical expenses
Early withdrawals from SEP IRA accounts can create significant shortfalls in expected retirement income and should not be considered or undertaken lightly. Used wisely, however, these withdrawals can put plan participants in a better financial position and provide additional funds when the need is greatest.
Tim Ord
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