Posted by Abundant Wealth Planning LLC

SEP-IRA: Simple Retirement Plan For Employees

SEP-IRA: Simple Retirement Plan For Employees

Saving for retirement as an entrepreneur can be complicated and expensive, but it doesn't always have to be. If you are an entrepreneur, several retirement accounts can be easily set up, especially for the unemployed. For those who own a small business with no employees, a SEP IRA is the easiest way to reduce current-year tax debt and defer future income.

A SEP IRA is a traditional IRA designed for simple businesses with higher contribution limits. Like a traditional IRA, every dollar you contribute to your account is an above-the-line deduction for AGI. In other words, everything you contribute to your account reduces your income, dollar for dollar. Also, the same distribution rules apply to SEP IRAs as those applied to traditional IRAs. SEP IRA has some advantages over traditional IRA.

SEP IRA contribution limits are less than $57,000 (for 2020 tax year) or 25% of net income, after considering an individual's deductible portion of their tax and the owner's deduction for contributions on behalf of the plan. These higher contribution limits give the owner of the SEP-IRA the ability to eliminate larger tax obligations than the traditional IRA while saving more for retirement.

Another benefit of the SEP-IRA is the delay in contributing to the account until the business owner submits the tax return. An entrepreneur can postpone filing the return before the October submission deadline to make the SEP-IRA contribution for the previous tax year. For example, suppose a business owner pays taxes in March and finds he/she owes federal and state money. In that case, his/her tax preparer can calculate how much he/she has to pay a SEP IRA contribution to eliminate some or all of their tax liability.

The business owner can request an extension in April and pay what he owes. They can then save until the October filing deadline to make the previous year's SEP IRA contribution and file the return. This extension means that an entrepreneur can use the current year's income to reduce the previous year's tax debt. Thanks to the SEP-IRA contribution, the entrepreneur has reduced his income and tax obligations. If payment were made during the tax extension request in April, the payment would be refunded in whole or in part.

SEP IRAs are a simple and easy way for entrepreneurs to save for retirement and dramatically reduce their tax obligations. It has higher contribution limits than traditional IRA and offers more flexibility when making contributions. If you are a business owner and want to reduce your tax debt and retirement savings, contact a consultant.

Who can open a SEP IRA account?

The IRS states that any employer, including the self-employed, as sole proprietors, can establish a Simplified Employee's Pension (SEP-IRA).

To do this, a formal written agreement must be adopted.

You can do this in three ways, including:

  • Use an IRS-approved prototype, such as those offered by banks, insurance companies, and other financial institutions.

  • Use of an individually designed SEP plan document

  • Use of the IRS SEP form with the Form 5305-SEP simplified employee pension - Contribution contract for an individual retirement account

The easiest option for most independent small business owners is to open a SEP IRA through a broker.

Where you can open a SEP IRA account

Opening a SEP IRA is comparatively easy compared to other types of independent retirement accounts. Most major brokerage firms will help you set up a SEP IRA account.

There are other options. Check with your brokerage firm, financial advisor, or preferred financial institution to see if they offer SEP IRAs.

Contribution rules and restrictions for SEP IRA

When you contribute to a SEP IRA, there are but a few rules to note.

Employer Contribution Only

First, only employers can contribute to a SEP IRA. Employer contributions can represent up to 25% of an employee's salary.

In the case of contributions, the same percentage of compensation must be used for all eligible plan members. This means that if you have qualified employees, you must contribute the same percentage of their compensation as you do yours. This is why SEP-IRAs are best for the self-employed, with few or no employees.

Annual Maximum contributions

There is also a dollar limit for contributions.

For the 2020 tax year, the maximum contribution is $57,000 or 25% of compensation, whichever is lower ($58,000 for 2021).

If you are self-employed, your salary is considered to be your net self-employment income after deducting half of your self-employment tax and IRA SEP contributions.

Unfortunately, this means that your maximum actual contribution is less than 25% as a self-employed person.

Thankfully, It is not necessary to contribute to the SEP-IRA every year. However, when you decide to do it, you need to do it for all employees.

SEP-IRA contributions are 100% vested immediately. This means that any employee can withhold contributions, even if they leave the company the day after their contribution.

Contribution deadline

It is not necessary to make contributions to a SEP-IRA before the end of the calendar year. Rather, they can be made up until the company's tax filing deadline.

Traditionally, the deadline is March or April, depending on the type of business entity you operate. However, it is usually possible to register an automatic six-month extension, which can delay the contribution deadline until October.

Withdrawal rules for SEP IRA

According to the IRS, the withdrawal rules for SEP IRAs are the same as for regular IRAs. This means that you can start withdrawing without penalty from the age of 59½.

If you retire before the age of 59.5, you will likely be subject to an additional early withdrawal fee of 10%. Since SEP IRAs are a traditional type of retirement account, you will also need to pay a withdrawal fee.

Pros and Cons of Using SEP IRA

As with any retirement account, using a Simplified Pension IRA (SEP) has many advantages and disadvantages.


Keep these positive characteristics in mind when considering a SEP IRA.

  • Deferred taxes: This is a significant amount that can be set aside for retirement. It can also give your business a good tax deduction. You have to pay income tax during retirement, but you might be in a lower tax category when you make these withdrawals.

  • Easy to set up: SEP-IRAs allows you to effortlessly set up a retirement plan for you and your employees.

  • Excellent maximum contribution: SEP IRAs allow you to contribute up to $57,000 per year if your salary allows it.

  • Flexible contribution and establishment rule: You don't have to make contributions every year. Instead, your options are quite flexible. If you are away for a year, you can choose a minor contribution or no contribution. Unlike other types of self-employed retirement plans, you can set up and contribute to a SEP IRA until your taxes are due, not before the end of the calendar year. This can result in a deductible expense before filing taxes. It also lets you save even more for retirement if you don't go past the calendar year deadline for other types of pension accounts.


There are some drawbacks to consider with SEP IRAs as well.

  • Employees are rewarded immediately: To make things even less flexible, employees immediately vest in their contributions. They can leave the day after your contribution and can keep every penny.

  • Less flexible contribution options: Regrettably, SEP IRAs don't have the same flexibility as other types of plans in some ways. First of all, you don't have a traditional and Roth option. Instead, all contributions are traditional. This means that you don't have the option of paying your contribution taxes now and receiving tax-free money when you retire. If you have qualified employees, they should receive the same percentage of contribution as you. It can cost you a lot of money to save a large amount because you have to send the same percentage of payment to your eligible employees. SEP-IRAs only allow employer contributions, so employees cannot contribute through the plan.

  • No loan options: SEP IRAs do not allow you to set up retirement loans as other plans do. While this is a good thing because you and your employees can't steal your future pension funds for unnecessary purchases, it's much less flexible if you really need the money.



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