If you’re self-employed, you may be wondering what options you have to save for retirement. The good news is that there are several different options, depending on your needs. Figuring out the best option for you and your retirement goals can be the challenge— but we are here to help.
One option many of our clients chose is to open a SEP IRA. They’re easy to set up and maintain, with no reporting requirements and adjustable contribution limits. This flexibility is exactly what many small business owners are looking for and we are happy to help you make the best decision for your business.
Who Qualifies for a SEP?
A Simplified Employee Pension (SEP) account is an IRA for small business owners with one or more employees, or anyone with independent (self-employed) income. Unlike the Traditional or Roth IRA for individuals (which has a specific contribution deadline, generally April 15), SEPs are different. The deadline for establishing and contributing to a SEP IRA is the filing deadline for the employer's tax return, including extensions for which year the contribution will apply for.
There are many reasons our clients open SEP IRAs for their business. Aside from the overall ease of plan management, you can vary the contribution amount depending on the ebb and flow of business. For example, say a construction company opens a SEP plan for their employees. They chose this plan due to the cyclical nature of the industry, so in good years they can contribute more but in off years reduce the percentage. With a self-directed SEP, employee John Doe can decide where and what to invest in— though he cannot make any additional contributions. The account is solely owned by him and is under his control.
A SEP IRA is tax deferred. That means up-front tax breaks and tax-deferred savings, so you don't pay taxes until you withdraw the money from the account during your retirement. One big advantage of a SEP IRA is the higher contribution limit. For 2018, the SEP contribution limit is up to 25% of individual compensation, with a maximum of $55,000. That amount increased for 2019. The 2019 SEP contribution limit is still up to 25% of compensation, but now with a maximum of $56,000— compared to a maximum of $6,000 ($7,000 with a catch-up contribution) allowed in a Traditional or Roth IRA. The SEP IRA doesn’t allow for catch-up contributions like other IRAs because the employer makes the contributions to the SEP, not the employee.
Since the employer is making the contributions, the amounts are related to the employees' salary or wages. This means that everyone’s contribution is the same percentage of salary. If you make a 25% SEP IRA contribution on behalf of yourself as the owner, you also must make a 25% contribution for your employees who qualify to participate in the plan.
However, not all employees may be eligible to participate in the SEP IRA. Employees must be included in the SEP IRA if they:
- Attained age 21;
- Worked for your business in at least 3 of the last 5 years;
- Received at least $600 in compensation (in 2016 - 2019) from your business for the year.
You can decide to have requirements for eligibility that are less restrictive (i.e. attained age 18), but not more restrictive than what is listed above.
One neat thing about a self-directed SEP IRAs with IRA Resources are that the participants can invest in a wide variety of different investment types. The self-directed SEP IRA has all the same limits and rules as a regular SEP, but allows investments in alternative assets. The higher contribution limits allow you to invest in alternative assets (like real estate) faster. You could be contributing as much as $56,000 per year to help you reach your retirement goals.
Distributions from a self-directed SEP IRA work like any other tax deferred IRA. Distributions are treated as ordinary income and subject to income tax (and if you are under the age 59 ½, early withdrawal penalties) when a withdrawal is made.
Things to Remember
- The IRS has a handy checklist for business owners to use to determine their eligibility for a SEP IRA. You can use this to help you make sure your plan is compliant with IRS regulations.
- You must contribute the same percentage for all employees, including yourself. If the business contributes 20% of your income to your SEP account, it must also contribute 20% of each individual employee’s income to their personal SEP accounts.
- The SEP IRA cannot issue a loan to the account-holders, and the assets cannot be used as collateral.
- SEP IRAs do not allow catch-up contributions, unlike some other accounts— the maximum contribution is capped at 25% of an individual’s compensation (with a maximum amount of $56,000), per tax year.
- Employees cannot contribute any additional funds to their SEP accounts— the contribution is limited to the percentage set by the employer.
- If an employee leaves before the end of the plan term, you must still contribute to their SEP account, even if they have already left your employ. They must receive the same percentage contribution as the rest of your employees.
- Your business can deduct your contributions to employee SEP accounts. The IRS has more detailed information on limits and allowances here.
SEP IRAs are inexpensive, easy to setup, easy to maintain, and do not require annual IRS filings like 401(k) accounts. With a self-directed SEP, you have all those benefits plus the flexibility to invest in almost anything. Why wouldn’t you want to start saving for your retirement today?