If you own a business and want to save for retirement, consider setting up a simplified employee pension individual retirement account. A SEP IRA can help you and your employees put aside funds for the future. However, make sure this type of retirement account is a good fit for your company and aligns with your long-term financial goals.
As you consider opening a SEP IRA, understand the following:
— What is a SEP IRA?
— How to open a SEP IRA
— SEP IRA contribution limits
— SEP IRA contribution deadline
— SEP IRA rules
— How to invest your SEP IRA
What Is a SEP IRA?
This type of retirement account is designed for small business owners. If you work for yourself or have several employees, you may be eligible for a SEP IRA. “Similar to a traditional IRA, SEPs are retirement accounts in which business owners can make tax-deductible contributions toward their retirement,” said Kevin Dugan, financial advisor and partner at Dugan Brown Federal Retirement Experts in Columbus, Ohio, in an email. The invested funds grow tax-free until they are withdrawn in retirement. When distributions are made, they are considered taxable income.
[How to Save for Retirement If You Work Part-Time]
How to Open a SEP IRA
When opening a SEP IRA, follow these steps:
1. Work with a financial advisor to help establish the account with a custodian.
2. Create a formal agreement using IRS Form 5305-SEP.
3. Provide information to employees who are eligible for the plan.
4. Set up accounts for yourself and your employees.
5. Make contributions to the accounts.
SEP IRA Contribution Limits
An employer can contribute up to $69,000 or 25% of compensation to a SEP IRA in 2024, whichever is lower. Contributions can only be calculated on up to $345,000 of compensation. The contribution limits for a SEP IRA are significantly higher than the $7,000 to $8,000 limit for traditional and Roth IRA contributions.
The contributions are made by the employer on behalf of the employee. “The contribution is based on taxable self-employment earnings, which are typically hard to calculate until the tax return for the year has been prepared,” said Ryan McClung, a certified public accountant and financial planner at Crossroads Advisory in Lake Oswego, Oregon, in an email. “So most often, the contributions are not made until after the tax year-end.”
[Read: Ways to Save for Retirement Without a 401(k)]
SEP IRA Contribution Deadline
Typically, any funds you want to place in a SEP IRA must be contributed by the time your business files taxes for that year. This is generally April 15 of the following year.
SEP IRA Rules
Before offering a SEP IRA to workers, you’ll want to confirm their eligibility. Employees must be 21 or older and have earned at least $750 in compensation during the current year. They also need to have performed services for the company during three of the previous five calendar years.
As an employer, you may choose to be less restrictive on eligibility requirements, but you’re not allowed to create more restrictive requirements. If your employees meet the criteria, you’ll need to create an account for them. If they aren’t eligible and you still choose to include them in the plan, you may do so.
Contributions must be made without discrimination. “Employers must make equal percentage-based contributions to their employees’ accounts as they contribute to their own account, which can be expensive,” Dugan said. If you have three employees who are eligible and decide to make contributions, you’ll need to put funds into all three accounts as well as your own.
For instance, if you, as the company owner, contribute 5% of your income to a SEP IRA, you’ll need to contribute that same percentage of income for each employee. If your income is $100,000 and you contribute 5%, or $5,000 of your income to a SEP IRA, you’ll need to contribute the same proportion of income for each employee. If an employee earns $10,000, you’ll need to contribute 5%, or $500, to the employee’s account.
For a company that has many employees, a SEP IRA may not be the best choice. The plans could quickly become costly for growing companies that will add additional staff members in the future. However, if your company has a high turnover rate, you may not need to create accounts for many employees.
[READ: Deciding Between a Roth vs. Traditional IRA.]
How to Invest Your SEP IRA
Funds that are placed in a SEP IRA can be invested in different ways. “SEPs can invest in a wide range of investments, including stocks, bonds, mutual funds and ETFs, which is the same as most retirement accounts,” said Ryan Cullen, co-founder and CEO of Cullen Cioffi Capital Management in Cincinnati, in an email. “Funds invested into SEP IRAs are immediately vested, meaning the employee now owns the amount invested, even if they were to leave the company.”
Distributions can be taken from the account starting at age 59 1/2. If funds are taken out before then, there is usually a penalty that must be paid for early withdrawal. Required minimum distributions must be taken after age 72.
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What Is a SEP IRA? originally appeared on usnews.com
Update 08/19/24: This story was published at an earlier date and has been updated with new information.
