Do SEP IRA Withdrawals Count as Income?
A simplified employee pension-individual retirement account, commonly referred to as an SEP-IRA, provides a simple, cost-effective mechanism for independent business people and small business owners to set aside retirement money for themselves and their employees. Contributions typically go into your SEP-IRA on a pre-tax basis, and withdrawals are taxed as ordinary income under the same rules as traditional IRA withdrawals.
The money in your SEP-IRA belongs to you as soon as the money is deposited into your account. The same rule applies whether you are self-employed and you contributed the money yourself, or if work as an employee for a small business that made the contribution on your behalf. Just as with a traditional IRA, since the money in the account belongs to you, you can withdraw it anytime you wish.
Contributions to your SEP-IRA are typically made with pre-tax dollars, and the investments in your account are allowed to grow tax-deferred. The same tax rules that apply to withdrawals from traditional IRAs apply to withdrawals from your SEP-IRA, so any portion of your withdrawal that is attributed to pre-tax contributions or tax-deferred growth is taxed as ordinary income in the year you take the withdrawal.
Early Distribution Penalty
You can start taking qualified distributions from your SEP-IRA once you turn age 59 1/2. If you withdraw money from your account prior to that, you'll usually owe a 10 percent early distribution penalty in addition to ordinary income taxes. You can avoid the tax penalty under certain circumstances, such as if you become permanently disabled or use the funds to buy or build a first home.
Some SEP-IRA plans may allow you to make contributions of after-tax money to the account. Any portion of your withdrawals that are attributed to such after-tax contributions are not taxed -- for example, if your SEP-IRA is worth $100,000 and $10,000 of it came from after-tax contributions, 10 percent of your withdrawal is tax-free. You don't owe taxes on those dollars, since you already paid taxes on those funds before they went into your account.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.