SEP IRASelf-Directed SEP IRA Retirement Plans

Are you self-employed or own a business and looking for an alternative to the traditional IRA or 401(k)? Find out if a SEP IRA is right for you.

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What Is a SEP IRA?

A Simplified Employee Pension Individual Retirement Account (SEP IRA) is an alternative IRA used for retirement savings. SEP IRAs allow business owners to set aside up to 25% of an employee’s income for their retirement account and don’t have many of the upfront costs and fees that traditional IRAs have.

A SEP IRA can be set up for business owner and their employees, making this a very attractive alternative for business owners looking to access the company-wide benefits of a 401(k) inside an IRA.

SEP IRA accounts offer the same tax advantages and investment options as other IRAs.

SEP IRA Eligibility

SEP IRAs are designed for self-employed individuals and small-business owners seeking an investment vehicle for tax-deferred retirement savings. To meet the eligibility requirements for a SEP IRA, the following must apply:

  • You earn self-employment income/freelance income by providing a service.
  • You’re a business owner.
  • You’re in a partnership.
  • You’re a sole proprietor.

Employers must contribute on behalf of their employees to a SEP IRA because they are considered eligible plan participants by the IRS. 

Based on IRS rules, employee contributions must match an equal percentage of compensation given to the business owner. 

Additionally, employees can be eligible for SEP IRA participation if they are at least 21 years of age, have worked for an employer for three of the past five years, and have made the IRS’s current minimum income requirement ($650 in 2022).

SEP IRA Pros and Cons

SEP IRAs offer unique benefits for both business owners and self-employed workers. The SEP IRA is generally considered a top investment option for someone who desires flexibility in the amount they can contribute annually.

The high limit for annual contributions also makes the SEP IRA an attractive option for someone with ambitious retirement goals.

Pros:

  • SEP IRAs are easy to set up.
  • They also come with easy, inexpensive administration.
  • As of 2022, SEP IRAs have a contribution limit of $61,000.
  • SEP IRAs can be combined with both traditional IRAs and Roth IRAs.
  • Qualifying SEP IRA contributions are tax deductible. That even includes contributions made to employee accounts.

These accounts offer flexibility. While SEP IRAs have high contribution limits, there’s no need to commit to contributing every year.

Cons:

  • There’s no Roth option for a SEP IRA. As a result, you’re locked out of the Roth-specific option for paying taxes on contributions now to take tax-free distributions in retirement.
  • If you contribute to a SEP IRA as an employer, you’re required to make proportional contributions for every eligible employee.
  • A SEP IRA’s required minimum distributions start at age 72.
  • In addition to being taxed as income, all distributions taken before age 58.5 are also subject to a 10% penalty. So this isn’t a good option if there’s a high likelihood of withdrawal before age 59. However, early withdrawal exceptions can apply.

SEP IRA Individual and Employer Contribution Limits

Contribution limits differ based on your status as either an employer or employee. As of 2022, employers can either contribute up to 25% of an employee’s total compensation or $61,000. 

If you’re a self-employed person, contributions are generally limited to 20% of net income.

Something that makes SEP IRAs unique is that employees can’t defer salary for contributions. For the 2022 tax year, employees are permitted to make contributions of up to $6,000. That jumps to $7,000 for employees over the age of 50.

SEP IRA Investing Rules

When opening a SEP IRA for more than one person, the account holder can choose from various mutual funds. Other investment types aren’t permitted with a SEP IRA like they are with a self directed IRA.  

However, one-person SEP IRAs actually provide a much wider range of investment options. Account holders of one-person SEP IRAs can diversify using mutual funds, exchange-traded funds (EFTs), individual stocks, bonds, and CDs (certificates of deposit).

SEP IRA Fees and Tax Benefits

One of the big draws of the SEP IRA is that it doesn’t have the start-up and operating costs of conventional retirement plans. There is no cost to open an account. However, other fund fees, account fees, and brokerage commissions may apply.

SEP IRAs also come with tax benefits. For employers, all contributions made are tax deductible. For employees, there is the benefit of growling tax-deferred earnings.

SEP IRA vs. Traditional and Roth IRAs

While SEP IRAs and Roth IRAs both offer tax benefits upon retirement, these two options come with tax tradeoffs that investors should know about. For example, SEP IRA offers tax-deferred growth on your investment. A Roth IRA provides tax-free growth and withdrawals.

Another difference between SEP and Roth IRAs is that SEP IRAs allow employers to add employees to their accounts. Roth IRAs are strictly for self-employed workers. 

SEP IRA contribution limits are higher than limits for traditional IRA contributions. With the difference being $61,000 versus $6,000, this is no small detail for people with big retirement plans.

It’s also interesting to compare the SEP IRA with the Savings Incentive Match Plan for Employees or SIMPLE IRA when deciding between employer-sponsored retirement plans. While only employers can contribute to the SEP, the SIMPLE IRA allows employees to contribute using elective deferrals that remove money from their paychecks. 

Additionally, SIMPLE IRA contributions are capped at $14,000. While that limit is lower than the SEP limit, SIMPLE IRAs do allow for a “catch-up” of $3,000 for employees over age 50.

How to Open a SEP IRA

Opening a SEP IRA is considered easy. Both employers and self-employed workers can create a formal written agreement using IRS Form 5305-SEP. It’s generally recommended to collaborate with an account provider like Horizon Trust. 

For employers, the next step is to give all eligible employees information about the SEP IRA. Finally, accounts can be set up for each employee online with a custodian like Horizon Trust on our website or by talking to a sales representative.

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