What Is A SEP-IRA? And Is It The Right For Your Small Business?

by | Aug 12, 2022 | Business Planning | 0 comments

Business owners have a variety of ways to save for their own retirement, and that of their employees. One option is to use a Simplified Employee Pension (SEP), where money is placed inside an Individual Retirement Account (IRA) for all plan participants. This is what’s known as a SEP-IRA.

With so many options at your disposal, it’s hard to know what retirement plan is right for you. So together, we’re going to break down the pros and cons of a SEP-IRA. And we’ll also review who’s eligible, and how to set one up.

SEP-IRA Rules?

Technically, any employer is eligible to establish a SEP-IRA. However, SEP-IRAs are typically best suited to employers with few to no employees. That’s because employers are mandated by the IRS to contribute on the behalf of all eligible participants.

It’s also a requirement that the contributions made to participant accounts match that of the owner’s in percentage of pay. For example, if you as the employer set aside 10% of your pay into your SEP-IRA, then you must also contribute 10% of a participant’s pay into their corresponding account.

According to the IRS, eligible participants in a SEP-IRA include those who:

    • Are age 21 or older
    • Have worked for you for at least 3 of the past 5 years
    • Earned a minimum of $600 for 2019-2020, or $650 for 2021-2022

SEP-IRA Contribution Limits for 2022?

SEP-IRAs allow for substantial contributions. But there are still limits on how much you’ll be able to set aside each year. And know that Sep-IRA contribution limits are likely to change annually per IRS guidelines. In 2022, contributions cannot be greater than the lesser of

    • 25% of compensation, or
    • $61,000 total

The 25% of compensation applies to all plan participants (including the owner). And in 2022, the amount of pay you can use to calculate the 25% hits a maximum at $305,000. You should also be aware that you cannot make catch-up contributions with a SEP-IRA. No contributions exceptions are made based on a participant’s age.

Pros Of A SEP-IRA

Compared to other retirement vehicles, the contribution limits for SEP-IRAs are substantially higher. For example, contributions hit a maximum at only $6,000 for both traditional and Roth IRAs in 2022. But again, for SEP-IRAs, that maximum can go as high as $61,000.

SEP-IRA contributions are tax-deductible. So, similar to a traditional IRA, you’ll be able to write off your contributions to the full extent the IRS allows come tax season.

SEP-IRAs are also very flexible. They can actually be used in tandem with other IRA accounts like a traditional or Roth IRA. And on top of that, you don’t have to make a commitment to contributing to your SEP-IRA each year.

Cons Of A SEP-IRA?

Unfortunately, there are also some drawbacks to using a SEP-IRA. As stated above, you can’t make any catch-up contributions as you (or any participants) get closer to retirement age. There’s also no Roth variety for SEP-IRAs. This means you won’t have the option of contributing with after-tax dollars.

SEP-IRAs are beholden to required minimum distributions. So you’ll have to begin making withdrawals starting at age 72. Additionally, any withdrawals made before age 59½ will be taxed as income and subject to 10% penalty, unless its use falls under an early withdrawal exception.

How Do You Set Up A SEP-IRA?

Thankfully, setting up an SEP-IRA is quite simple. You’ll first have to choose a provider (ex: Fidelity, Merill Lynch, Etrade, etc.), then follow the proper IRS guidelines. These include the following 3 steps:

1. Create a written agreement for providing benefits to all eligible participants. For this you’ll want to speak with your provider, or use a IRS Form 5305-SEP.

2. Provide eligible participants with the necessary information regarding the SEP-IRA. And if you use the IRS Form 5305-SEP, you’ll need to give a copy to each participant.

3. Establish an IRA for each participant through your provider.

Please Note: The deadline to set up a SEP for a given year is as late as the due date (including any extensions) for your business’s income tax return.

Learn About:

  1. Solo 401(k)
  2. SIMPLE IRA

How Can Vertical Wealth Management Help?

At Vertical Wealth Management, we help business owners prepare for their retirement, and that of their employees. And we understand how overwhelming it can feel trying to make these decisions on your own.

Our team takes a hands-on, consultative approach in determining what retirement plan(s) work best for you, and your business. And we’re able to answer all your questions regarding savings, taxes, and conversions of your retirement vehicles.

If you’re ready to get going with a SEP-IRA, feel unsure, or want to weigh your other retirement options, we’re here to help. Schedule your free consultation call today, and find the retirement solution that works best for you.