If you own a small business, are self-employed, or actively freelancing, then choosing the optimal retirement savings plan can be difficult. One option, however, is the simplified employee pension plan.
A simplified employee pension plan, also known as a SEP IRA, is similar to a traditional IRA but offers unique benefits for specific account holders.
Think a SEP IRA may be right for you? Here are a few things you need to know.
1. SEP IRAs Can Also Benefit Employees
To open a SEP, you must be a business owner, self-employed, or a freelancer. However, that doesn’t mean you’re the only one that can benefit from a SEP IRA.
Once you open a SEP IRA, you’ll be required to make equal contributions to your account as well as the account of any eligible employees. For instance, if you decide that you want to contribute 10% of your income to your SEP IRA, you’ll also need to contribute 10% of an eligible employee’s compensation to their account.
2. SEP IRAs Are Best For Businesses Few To No Employees
If you’re a freelancer or are self-employed, then you’ll find there are a few drawbacks to a SEP. The same is true if you’re a small business owner with few to no employees. However, due to the employee-based contribution requirements referenced above, if you have several employees and intend to grow, a SEP can lack scalability.
3. SEPs Have Higher Contribution Limits Than SEP IRAs
Currently, IRA contribution limits are set at $6,000 ($7,000 for those over 50) annually. With a SEP, however, investors can contribute up to 25% of their net income up to $56,000. This can make them more valuable to individuals with more aggressive retirement goals.
4. SEPs Can Offer Annual Tax Savings
SEP contributions are tax-deferred, which means funds are invested with pre-taxed income. This can help you lower your annual tax bill while increasing your retirement savings. If you’re a small business with SEP-eligible employees, you can also deduct those contributions.
Keep in mind, however, that like a traditional IRA, SEP distributions are taxed. If you prefer tax-free distributions, this plan won’t be for you.
5. Distribution And Withdrawal Rules Mimic Those Of A Traditional IRA
Generally, withdrawals that occur before the age of 59 ½ are subject to a 10% penalty, though there are exceptions like educational, medical, or first-time home buyer’s expenses. Similarly, once SEP participants reach the age of 70 ½, they must begin to withdraw what’s known as required minimum distributions (RMD).
6. Contributions Can Be Flexible
SEP IRAs allow investors to change contributions year to year. For instance, if you’re having an exceptionally profitable year, you can choose to maximize SEP contribution limits. If, however, you’re just getting started or business has become stagnant, you can choose to lower or pause contributions.
7. Not All Employees Are Eligible For A SEP
To participate, an employee must be at least 21 years old, have worked for the company for at least three out of the last five years, and earned at least $600 in compensation throughout the year.
8. You Can Have A SEP In Addition To Other Types Of Retirement Plans
Enrollment in a SEP doesn’t limit your eligibility in other retirement plans. For instance, if you have an employer-sponsored 401K but also have self-employment income on the side, you can still open and participate in a SEP. There’s no need to pick and choose; you can grow your retirement as you see fit.
9. Opening A SEP IRA Account Is Easy
SEP plans require minimum paperwork. All you have to do is complete a written agreement (commonly the IRS 5305-SEP form), inform any eligible employees, and set up an IRA account. Horizon Trust can guide you through each step of the process.
10. You Can Choose A Self-Directed SEP IRA
If you want to maintain more control over how your money is invested, a self-directed IRA can become a valuable tool. Instead of limiting your investment strategy to stocks, bonds, and mutual funds, a self-directed SEP IRA account can extend your investment portfolio to include real estate, commodities, and more.
If you’re a small business owner, freelancer, or otherwise self-employed, a simplified employee pension plan may be the right retirement plan for you. With high contribution limits, annual flexibility, and tax advantages, a SEP IRA can put you on the fast track to maximized retirement savings. Contact us for more information today!