If you’re self-employed, you may be wondering what options you have to save for retirement. The good news is that there are a few different self-employed IRAs that small business owners can take advantage of depending on their need— SIMPLE IRA, Individual 401(k) and, the SEP IRA. Figuring out the best option for you and your retirement goals can be a challenge, but we got you covered.
One option many of our clients choose to open is 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 or self-employed individuals are looking for in a retirement plan and we can help you get one started. Here's everything you need to know about SEPs.
- SEP Contribution Limits
- Who Qualifies for SEP
- How to Set up a SEP
- SEP IRA Distributions
- SEP IRA Rules
- SEP IRA FAQs
The Benefits of Self-Directed SEP IRA
A Simplified Employee Pension (SEP) account is an IRA for small business owners with one or more employees or anyone with an independent (self-employed individual) income. 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 as an employee, the account is solely owned by him and is under his control.
The neat thing about a self-directed SEP IRA with IRAR is that the participants can invest in a wide variety of 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.
SEP Plan Contribution Limits
SEP IRA contributions are made by the employer, pre-tax. That means an up-front tax break or tax-deferred savings for your business. The employee doesn't pay taxes until they withdraw the money from the account during retirement. Another big advantage of a SEP IRA is the higher contribution limit.
In 2020, the SEP contribution limit was up to 25% of individual compensation, with a maximum of $57,000. That amount increased for 2021. The 2021 SEP contribution limit is still up to 25% of compensation, but now with a maximum of $58,000.
The annual contributions allowed in a SEP are much higher compared to a maximum of $6,000 ($7,000 with a catch-up contribution if 50 or older) allowed in a Traditional or Roth IRA. The SEP IRA doesn’t allow for catch-up contributions at age 50 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 their individual salary.
For example, if you make a 25% SEP IRA contribution to yourself as the owner, you also must make a 25% employer contribution for your employees who qualify to participate in the plan. Contributions must be made in cash; you cannot contribute property.
Another important thing to note is that an employer contribution to a SEP-IRA won't affect the amount an employee can contribute to a Roth IRA or a Traditional IRA. However, it may prevent the employee from receiving a tax deduction for contributions to a Traditional IRA.
Who Qualifies for a SEP IRA?
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 $650 in compensation for 2021 ($600 for 2019- 2020) from your business.
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.
Also, you can exclude employees covered by a union agreement whose retirement benefits were bargained for in good faith by the employees' union.
How to Set Up a SEP IRA
You can set up a SEP retirement plan for all eligible employees by executing a formal written agreement, form 5305-SEP that you get from your IRA custodian when you open the account. You must give each eligible employee a copy of this form. The SEP isn't considered adopted until you give each employee this information
An individual retirement account (IRA) is established for each employee by the custodian for the employer to make contributions. IRAR can help you establish your SEP and employees’ individual retirement accounts. Once the accounts are set up, you would send the contributions directly to IRAR.
Set up and Contribution Deadline
Unlike the Traditional IRA or Roth IRA for individuals (which have a specific contribution deadline, generally April 15), SEPs are different. The deadline for establishing and contributing to a SEP IRA depends on when your business files its income tax returns.
The deadline for setting up a SEP IRA is May 17 or your business' tax-filing deadline including extensions. Generally, this would be April 15 but the deadline was extended due to the COVID-19 pandemic.
SEP IRA Distributions
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 by participants.
Required Minimum Distributions (RMD) rules apply to SEPs. Due to changes made by the SECURE Act in 2019, if your 70th birthday is July 1, 2019, or later, you do not have to take distributions until you reach age 72.
SEP IRA Rules And Important 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 $57,000 for 2020 and $58,000 for 2021), 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. These are tax-deductible. The IRS has more detailed information on limits and allowances.
SEP IRAs are inexpensive, easy to set up, 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?
SEP IRA FAQs
When is the SEP IRA Contribution deadline?
The deadline to establish a SEP IRA is May 17, 2021, or the employer's tax-filing deadline, including extensions. Due to the COVID-19 pandemic, this deadline was extended along with the tax filing deadline for 2020.
Who qualifies for a SEP IRA?
A Simplified Employee Pension (SEP) account is an IRA for small business owners with one or more employees or anyone with independent (self-employed individual) income. This IRA allows higher contributions than a Traditional or Roth IRA.
What is a SEP IRA?
A SEP IRA or Simplified Employee Pension is a retirement plan for small businesses with one or more employees. You, the business owner count as an employee. This plan allows higher contribution limits than most IRAs.
Can an employee contribute to a SEP IRA?
No. An employee cannot contribute to a SEP IRA, only the employer. However, the employee can set up a separate individual retirement account and make contributions not to exceed the total allowed for the year.
What is the deadline to set up a SEP IRA?
You can set up a SEP IRA for your business before your business' income tax return due date (including extensions) for that year. The IRS sent out a press release extending the deadline to May 17th, 2021 for the tax year 2020. This applies to individuals to make 2020 contributions to their individual retirement arrangements (IRAs and Roth IRAs), health savings accounts (HSAs), Archer Medical Savings Accounts (Archer MSAs), and Coverdell education savings accounts (Coverdell ESAs).