SEP IRA: Benefits, Rules, and How to Get Started

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What Is a SEP IRA?

A Simplified Employee Pension (SEP) IRA is a tax-advantaged retirement account that allows business owners to contribute to their employees’ retirement as well as their own. Contributions to a SEP IRA are tax-deferred, meaning they can be deducted on tax returns. Similar to traditional IRAs or 401(k) plans, SEP IRA distributions are taxable as regular income upon withdrawal during retirement.

SEP IRA Basics

While SEP IRAs share many features with traditional IRAs, setting one up is slightly more complex. Here are some fundamental rules:

• Each employee must have an individual SEP IRA account.
• All contributions are made by the employer; employee contributions are not allowed.
• The contribution rate must be consistent for all eligible employees.
• Contributions can vary annually.
• Contributions must be made by the company’s tax filing deadline.

SEP IRA Contribution Limits

For 2023, the maximum contribution to a SEP IRA is $66,000 or 25% of compensation, whichever is less. In 2024, this limit increases to $69,000, with a compensation cap of $345,000. These limits are higher than those for other types of IRAs, making SEP IRAs an attractive option for business owners and self-employed individuals.

SEP IRA Rules

The IRS has specific rules for SEP IRAs:

• Businesses of any size, including sole proprietors and nonprofits, can establish a SEP IRA.
• Eligible employees must be 21 or older, have worked for the employer for at least three of the past five years, and meet other IRS criteria.
• Self-employed individuals can contribute up to 25% of their compensation.
• Contributions are tax-deductible and fully vested immediately.
• Withdrawals are taxable, with a 10% penalty for early withdrawals before age 59½.

SEP IRA Pros and Cons

Pros

• Higher contribution limits compared to traditional IRAs and Roth IRAs.
• Fewer complex rules and filing requirements than 401(k) plans.
• Flexible contribution amounts from year to year.

Cons

• No Roth option available.
• Employee contribution rates must be equal to the employer’s rate.
• All contributions are made by the employer; employees cannot contribute.

How to Open a SEP IRA

To set up a SEP IRA, follow these steps:

1. Adopt a formal written agreement using one of these methods:
   • Complete and sign Form 5305-SEP.
   • Select an IRS-approved prototype SEP from a financial institution.
   • Create your own SEP plan document.
2. Provide each eligible employee with information about the SEP IRA plan.
3. Open a SEP IRA for each eligible employee through a brokerage firm, bank, credit union, or insurance company.

Ensure the SEP IRA is set up and funded by the due date for your business’s income taxes to deduct contributions on your tax return.

The Bottom Line

Whether you’re aiming to save for your own retirement or help your employees achieve their retirement goals, a SEP IRA offers a straightforward way to make tax-deductible contributions with high limits. For solo business owners and entrepreneurs, SEP IRAs are worth considering.

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