The Tax Consequences of Merging an SEP IRA & a Rollover IRA

A simplified employee pension is a type of traditional individual retirement account set up by small businesses and self-employed workers. A rollover IRA is a traditional IRA that receives transfers from qualified employer plans. You can funnel a rollover IRA into a SEP tax-free. You can also shovel a SEP into a rollover IRA tax-free, but the transfer may face a problem down the line.


In many respects, a SEP account is like its traditional IRA cousin. Both provide tax-deductible contributions, shield investments from current taxes and create taxable income when you tap the money. However, only an employer can contribute to a SEP IRA -- you can't. Each eligible employee gets a separate account. An employer isn't required to make contributions; if it does, it must follow a written funding formula.

Rollover IRA

The only difference between a rollover, or conduit, IRA and a traditional one is that a rollover IRA contains only the contributions and earnings transferred from a qualified employer plan such as a 401(k), 403(b) or 457. A rollover IRA can serve as a temporary holding account for employer distributions until you join another employer plan. Normally, you don't contribute or transfer other money into a rollover IRA because an employer plan may refuse to accept any transfers not stemming from another employer plan. This can create a problem if you transfer a SEP into a rollover IRA, since some employer plans might balk at SEP rollover money.


You can move money between a traditional IRA and SEP without tax consequences through a trustee-to-trustee transfer. You can also withdraw funds from one account and deposit them in the other, but you must complete the rollover within 60 days or the Internal Revenue Service will treat it as a taxable distribution. If you're younger than 59 1/2, the IRS may also slap a 10 percent penalty on the withdrawal. Unlike with other employer plans, you can take your money out of a SEP at any time. You don't have to leave your job to grab the dough.


A SEP can swallow up more money each year than other types of IRAs. As of 2013, your employer can contribute up to 25 percent of your compensation or $51,000, whichever is less. The contribution limit for an IRA is $5,500, or $6,500 if you're 50 or older. If you're self-employed, you must perform a special calculation to figure your maximum SEP contribution, using the worksheet in IRS Publication 560. Both account types require minimum distributions beginning at age 70 1/2, but only a SEP allows you to contribute after this age.

the nest