Can I Open an IRA or SEP If I Am Self-Employed?

Individual retirement accounts, or IRAs, are tax-advantaged retirement plans that were authorized by Congress and provide individual taxpayers with a means of saving for retirement. Simplified Employee Pension plans, often referred to as SEP IRAs, allow small-business owners and self-employed workers to set money aside for retirement in a tax-advantaged account.

History

• Congress first authorized the creation of IRAs in 1974 as part of the Employee Retirement Income Security Act. Individuals who earned an income but were not covered by a qualified retirement plan by their employer were eligible to open an IRA. The Economic Recovery Tax Act of 1981 extended eligibility to all taxpayers. Additional types of qualified retirement plans followed, including the Roth IRA, 401k plans and SEP IRAs.

Function

• Both IRA and SEP accounts were designed to provide a regular source of income for the individual following retirement. Individuals are allowed to contribute funds to these accounts on a tax-advantaged basis. It is expected that the account holder will contribute to her IRA or SEP during her wage-earning years, and withdraw funds from the account after retirement when her income, and presumably her income tax bracket, is lower.

Types

• IRAs are retirement accounts that are available to any individual taxpayer. SEPs are a form of pension plan that is available only to small businesses, sole proprietors and self-employed taxpayers. Individual taxpayers who have an SEP may also have an IRA. IRA holders who are not self-employed, sole proprietors, small-business owners or employees of a small business that offers an SEP may not have an SEP.

Features

• Contributions made to both IRAs and SEP IRAs are deductible from the taxpayer's federal income tax for the tax year in which they were made, subject to certain limits on the amount being contributed. Any income produced in these accounts is allowed to grow tax deferred until it is withdrawn. Contributions to both IRA and SEP IRA accounts may not be withdrawn without incurring a tax penalty until the account holder reaches 59½.

Time Frame

• Any taxpayer who earns taxable income and has not reached 70½ at the end of the tax year is eligible to have an IRA. Individuals must be at least 21 to be eligible for an SEP IRA. Both IRAs and SEP IRAs may be established and funded up to the taxpayer's tax filing date, which is typically April 15 for the preceding tax year. Taxpayers may not make contributions to an IRA once the account holder reaches 70½, and the account holder is required to begin taking mandatory withdrawals from his account at that time. Employers must make contributions to the SEP IRA account of all eligible employees, even after they reach 70½, but the employee must begin taking mandatory withdrawals from his account at that time.