Small business owners and self-employed individuals have a number of options available for retirement savings. One popular choice is the Simplified Employee Pension (SEP) individual retirement account (IRA). The SEP IRA is basically a traditional IRA at the core, with special conditions allowed for by the Internal Revenue Service (IRS). Read below to learn the basics of the SEP IRA as well as the advantages and the disadvantages of this type of plan.
SEP IRA Basics
The SEP IRA is available to any small business owner with one or more employees or self-employed individuals. SEP IRA plans are easy to establish and offer many of the same investment options as traditional IRAs. The main difference between the SEP IRA and a traditional IRA is that employers, not the employee, make contributions to the SEP IRA. Elective salary deferrals and catch-up contributions are not permitted in SEP IRA plans. Because only employers make contributions to the plan, contributions are only tax deductible for the employer. Employers may deduct the lesser of contributions paid to an employee or 25% of the employee’s compensation. Unlike other retirement savings plans, employers are not required to make contributions every year to SEP IRAs.
SEP IRA Advantages
The biggest advantage of the SEP IRA is that much higher annual contribution limits are available compared to other IRAs. The annual maximum contribution for a traditional IRA or Roth IRA for 2019 is $6,000. In comparison, the 2019 maximum contribution for a SEP IRA is the lesser of 25% of compensation or $56,000.
Another advantage is the IRS allows individuals to participate in both a SEP IRA plan and a traditional IRA or a Roth IRA. In the event an employee holds multiple IRA accounts, SEP IRA contributions are considered employer contributions and do not affect the individual contribution limits. That means it is possible for employees to reach the maximum employer contribution limit in their SEP IRAs and, at the same time, they can maximize individual contributions. And because the SEP IRA is a traditional IRA, it may be possible to make SEP and individual contributions to the same IRA account.
SEP IRA Disadvantages
The biggest disadvantage of SEP IRA plans is that employers are required to make proportional contributions for all employees. That means business owners cannot contribute a higher percentage of their own income to their SEP IRA plan in relation to their employees’ plans. For example, an employer is not allowed to contribute 25% of their salary to their own plan and only 20% of an employee’s salary to the employee’s plan. Because of this rule, employer contributions can become very expensive for business owners.
In addition to the contribution rules above, SEP IRAs are subject to the same guidelines as other IRA plans. The required minimum distribution (RMD) rules that start at 70½ years of age as well as early withdrawal penalties for withdrawals before the age of 59½ apply to SEP IRA plans.
Wickham Financial & Insurance Services offers support to small business owners and self-employed professionals exploring retirement savings options. Our team works closely with our clients to understand the essentials of their business and financial needs. Contact one of our financial advisors to learn how we can help you design the best retirement savings program for your business.
Any information provided has been prepared from sources believed to be reliable but is not guaranteed, does not represent all available data necessary for making investment decisions and is for informational purposes only.