Retirement Primer: All You Need to Know About SEP IRAs
With so many retirement account options, some of them can go unnoticed and underappreciated. One of these is the Simplified Employee Pension (SEP) plan, most commonly utilized as a SEP IRA, or individual retirement account. Let’s take a look at these retirement plans and how they work as well as the pros and cons of choosing one of these accounts for your retirement savings.
What is a SEP IRA?
The SEP IRA is an IRA for business owners that allows them to make contributions toward their employees’ retirements and to their own retirement savings. Investments grow tax-deferred until retirement, when distributions are taxed as income.
For every contribution you make to your SEP IRA, you’ll need to contribute a matching amount for each eligible employee in your company.
How much can I contribute to a SEP IRA?
If you are a business owner, and you’d like to open a SEP IRA, your contribution limits will be a lot higher than traditional IRAs. In 2024, a traditional IRA allows you to put away up to $7,000. Business owners aged 50 and older can contribute an additional $1,000. A SEP IRA, on the other hand, allows account holders to contribute up to nearly 10 times that amount, at $69,000 in 2024. However, there are no catch-up contributions for SEP IRAs.
There are other restrictions with SEP IRAs. First, annual contributions to a SEP IRA cannot exceed the lesser of $25,000 of compensation or $69,000 in 2024. In addition, you cannot contribute more than 25% of compensation for each eligible employee. The amount of compensation you can use to calculate the 25% has annual limits as well; in 2024, the limit is $345,000. Finally, employer contributions must be made by the date the company’s federal income tax return is due.
Contributions to a SEP IRA are tax-deductible. You can deduct the lesser of your contributions or 25% of compensation, as subject to the compensation cap described above.
Should every business owner open a SEP IRA?
SEP IRAs are best for self-employed individuals and small-business owners with few or no employees. This is because, if you have any employees whom the IRS deems eligible participants, you must contribute on their behalf – and these contributions must be an equal percentage of compensation to your own. In general, the IRS considers employees who are age 21 or older, have been employed by you for three of the past five years and have earned at least $750 in 2023 or 2024, eligible for a SEP IRA. So, if you want to contribute 20% of your compensation for yourself, you’ll also need to contribute 20% of each eligible employee’s compensation to their plan.
Pros of SEP IRAs
There are several advantages to SEP IRAs, including:
- High contribution limit
- Can be combined with a Roth or traditional IRA
- Simple to set up and use
- Tax-deductible contributions
- Flexibility, with no commitment to contribute every year
Cons of SEP IRAs
There also several disadvantages to SEP IRAs, including:
- Required matching contributions for each eligible employee
- There are no catch-up contributions for individuals aged 50 and older
- Required minimum distributions at age 73 and older
- Distributions taken before age 59½ are subject to a 10% penalty (unless qualified by an early withdrawal exception)
How do I open a SEP IRA?
Opening a SEP IRA is easy. You can open an account online through the IRS Form 5305-SEP(link is external), or through your account provider. You’ll also need to set up separate SEP IRAs for each eligible employee in the same fashion and inform your employees about the account.
To make contributions to your SEP IRA, you’ll choose from the investments offered by your account provider. You’ll likely have a choice between stocks, bonds and mutual funds. Pick an investment style that makes sense for your age, time until retirement and risk tolerance. If you’re not averse to risk, and time is on your side, you may want to choose to invest in stocks. And if you want a safe investment with your retirement soon approaching, you’re likely better off allocating your funds to bonds and other risk-free investments. Once you’ve selected your investment, you can make contributions in cash; you cannot contribute property.
SEP IRAs can be a beneficial retirement tool for small business owners. Use this guide to learn about these accounts and make an informed decision about opening one of your own.