What Is a SEP-IRA? Key Details You Need

A Simplified Employee Pension IRA (SEP-IRA) is a retirement plan for self-employed individuals or small business owners. This allows employers to make pension contributions for their employees and themselves (as employees).

A SEP-IRA allows your employer to deduct all contributions from your taxable income, and the income is tax deferred until withdrawn. This plan is easy to set up and maintain, making it an attractive option for those who want a retirement plan with minimal administration.

How does the Simple Employees’ Pension (SEP) work?

Simple Employees’ Pension (SEP) and SEP-IRA are practically interchangeable. This is because the SEP is always set up in her SEP IRA, which is held by each participant (employee). Employers make pre-tax contributions to a simplified employee benefit plan for each eligible employee. Your SEP IRA is managed by your chosen financial institution. Each participant has full control over how funds are invested in their account.

Important: With a SEP, you are both the employer and the employee. Employers don’t have SEPs; only employees do.

Employees invest your contributions based on offerings from the financial institution that administers the SEP-IRA plan. Typically, this includes a limited number of mutual funds, exchange-traded funds (ETFs), and individual stocks and bonds. Each individual’s account grows tax deferred. Participants will be able to begin withdrawing funds once they reach age 59 1/2, and will be required to pay taxes on withdrawals. Early withdrawals are usually subject to penalties and taxes.

SEP IRA Contribution Limits

Simplified Employee Pension (SEP) IRA contribution limits are subject to change each year based on the Cost of Living Adjustment (COLA) established by the Internal Revenue Service (IRS).

An employee’s contributions to her SEP-IRA in 2024 may not exceed the lesser of:

25% of the employee’s compensation or
$69,000.

Note: SEP plans do not allow elective salary deferrals and catch-up contributions.

Contributions to a SEP-IRA must be made by the tax filing deadline (including extensions) for the year in which the contributions are made.

SEP IRA Rules

Simplified Employee Pension (SEP) IRAs have several rules that employers and employees must follow:

Eligibility: Employers generally must include all employees age 21 and older in their plans. He was employed by the employer for at least three of the past five years and received compensation of at least $750 during those years.

Contribution limits: Employers may contribute up to 25% of an employee’s compensation annually, up to a certain compensation limit. The 2024 contribution limit is $69,000 and the compensation limit is $345,000.

Vesting: Contributions made on behalf of a SEP-IRA immediately vest in the employee, meaning the employee has full ownership and control of the funds.

Withdrawals: Withdrawals from a SEP IRA are subject to the same rules and penalties as traditional IRAs. Generally, withdrawals made before age 59 1/2 are subject to income tax plus a 10% penalty.

Required Minimum Distributions (RMDs): Employers are not required to make RMDs from SEP IRA plans, but employees must complete their SEP IRA plans by April 1 of the year following the year in which they apply. SEP-IRA plans begin at age 72 (or age 73 if they reach age 72 after December 31, 2022).

SEP-IRA rules may vary by plan and employer. Therefore, it is recommended that you consult a financial advisor or tax professional to ensure compliance with the planning rules.

SEP-IRA: Advantages and Disadvantages

SEP-IRAs have several advantages and disadvantages that employers and employees should consider when determining whether it is the right retirement plan for their needs. . If you’re considering setting up a SEP-IRA, consider the following pros and cons:

Pros:

Flexible contributions
Tax-deductible contributions (unless it’s a Roth)
High contribution limits
Easy to set up and maintain

Cons:

No catch-up contributions
Equal rate contributions required
May have no Roth option
Limited investment options

Advantages

Flexible Contributions: SEP IRAs are especially useful for businesses and self-employed individuals whose income tends to be cyclical (e.g., good years and bad years). A SEP-IRA allows your employer to make larger contributions during good times and smaller contributions during bad times. However, the employer contribution rate must be the same for all eligible employees.

Tax-deductible contributions: An employer can make tax-deductible contributions to her SEP-IRA on behalf of an eligible employee, thereby reducing her taxable income.

High contribution limit: His SEP-IRA contribution limit in 2024 will be $69,000 or his 25% of employee compensation, whichever is lower, and he wants to invest a large amount in his retirement savings. It’s a great option for people.

Easy Setup and Maintenance: SEP-IRAs are easy to set up and maintain because they do not require complex reporting requirements or annual filings.

Disadvantages

No Catch-Up Contributions: SEP-IRA contributions are typically limited to a percentage of employee compensation, and no additional catch-up contributions are allowed for employees over age 50. However, if your plan allows traditional IRA contributions to a SEP-IRA, you may be allowed to make tax-deductible catch-up contributions of up to $7,000 in 2024 ($8,000 if over age 50).

Identical Contribution Rate Required: Employers must contribute to SEP-IRA accounts every year if eligible employees contribute to their own SEPs (as employees). They must also pay the same contribution rate to all employees.

No Roth Option: SEP IRAs typically do not offer a Roth option, meaning all contributions and earnings are tax-deferred only until withdrawn. That’s because Roth options that allow for tax-free withdrawals became available only for SIMPLE and SEP IRAAs in 2023 under the SECURE 2.0 Act. Roth contributions are included in the employee’s income in the year the contributions are made.

Investment Options Restrictions: Depending on the financial institution where the account is maintained, an employee’s investment options within her SEP-IRA may be limited.

How could a SEP-IRA be opened?

Opening a Simplified Employee Pension (SEP) IRA is a simple process. How to Open a SEP-IRA as an Employer or Self-Employed:

Select a Financial Institution: The first step is to select a financial institution that will offer your SEP-IRA account. This could be a bank, brokerage firm, mutual fund company, or other financial institution. It is important to compare fees, investment options, and customer service before choosing a financial institution.

Completing the Application: Once you have selected a financial institution, you must complete the application to open a SEP IRA account. This typically involves providing personal and business information, such as your name, address, social security number, and business tax identification number.

Creating a Plan: After completing the application, your financial institution will provide you with the documentation to create his SEP-IRA plan. This may include planning documents, adoption agreements, and other required forms.

Determine employee eligibility: If you have employees, you need to determine which employees can (and must) participate in your SEP-IRA plan based on certain criteria, such as age and years of service. there is.

Contributions: After you set up your plan and determine your employee’s eligibility, you can make contributions to your eligible employee’s SEP-IRA account. You can contribute up to 25% of your employee’s compensation each year, within certain limits.

How should a SEP-IRA be invested?

Investing in a SEP IRA is similar to investing in other types of IRAs. Here are the steps you can take as an employee:

Choose an Investment Strategy

The first step is to choose an investment strategy that meets your retirement goals and risk tolerance. You can choose from a variety of investment options offered by financial institutions implementing your plan, including: B. A mutual fund, ETF, stock, bond, or target date fund.

Selecting an Investment

After choosing your investment strategy, select the investments you want to keep in your SEP IRA account. This may include researching various mutual funds, ETFs, and individual stocks and bonds and considering factors such as investment performance, fees, and risk. Keep in mind that SEP plans limit your investment options.

Monitoring Your Investments

Monitoring your SEP-IRA investments is important to ensure they are consistent with your investment strategy and retirement goals. You should periodically rebalance your portfolio by selling underperforming investments or adding new investments.

If you are new to managing investments, consider working with a financial advisor or investment professional who can help you select investments, manage your portfolio, and make investment decisions that align with your goals.

How is a SEP-IRA different from other retirement savings options?

Although there are many similarities between the various retirement planning options, there are also some notable differences. Here’s what you need to know:

SEP-IRA vs. Roth IRA

Tax Treatment: SEP-IRAs are tax-deferred retirement accounts. This means that your contributions are tax deductible in the year they are made, and your earnings are taxable. -Delays growth until lifted. Roth IRAs also have tax advantages. Earnings grow tax-free, but contributions are made in after-tax dollars and withdrawals are not taxed. SECURE 2.0 allows SEP IRAs to have a Roth option starting in 2023. Tax treatment is similar to a Roth IRA.

Contribution limits: SEP IRA contribution limits are typically higher than Roth IRA contribution limits. The 2024 SEP-IRA contribution limit is 25% of employee compensation, or less than $69,000. The 2024 Roth IRA contribution limit is $7,000 if you are under age 50. A person age 50 or older can contribute her $8,000 to a Roth IRA.

Eligibility: SEP-IRAs are generally available to self-employed individuals, small business owners, and employees. Roth IRAs are available to anyone who meets certain income requirements.

Employer Contributions: SEP-IRAs allow employers to make tax-deductible contributions to eligible employees. Roth IRAs do not allow employer contributions.

Required Minimum Distribution (RMD): A SEP-IRA allows the account holder to make required minimum distributions when she is age 72 (if he reaches age 72 after December 31, 2022, he is age 73). It requires you to start receiving money (RMD). Roth IRAs do not require RMDs during the lifetime of the original account owner.

SEP-IRA vs. SIMPLE IRA

Source of Contributions: Only employers are allowed to make contributions to SEP-IRAs. SIMPLE IRAs allow both employers and employees to make contributions.

Contribution Limit: Starting in 2024, the annual contribution limit for a SEP IRA is the lesser of 25% of each employee’s salary or $69,000. The annual contribution limit for a SIMPLE IRA is $16,000 per employee, plus $3,500 for employees over the age of 50.

Matching Contributions: SIMPLE IRAs require employers to match employee contributions up to 3%, or 2% if the employee does not contribute. These plans do not have this requirement because the employee does not contribute to her SEP-IRA.

Penalties and Limitations: With a SEP IRA, he is subject to a 10% penalty on funds withdrawn before age 59 1/2. Distributions must begin when he is 72 years old (if he reaches age 72 after December 31, 2022, he is 73 years old). SIMPLE IRAs impose a 10% penalty on withdrawals before age 59 1/2 and a 25% penalty if the account is opened less than two years.

SEP-IRA and Individual 401(k)

Contribution Limits: For SEP-IRAs, the maximum contribution limit is 25% of the employee’s income or $69,000 in 2024, whichever is lower. For an individual’s (individual) 401(k), the contribution limit is $23,000 in 2024, and $30,500 if over 50 years old.

Eligibility: SEP IRAs are available to self-employed individuals and small business owners with any number of employees. Individual 401(k)s are available only to self-employed individuals or business owners who have no employees other than their spouse.

Source of Contributions: Only employer contributions are allowed for SEP IRAs. Individual 401(k)s allow for both employee and employer contributions, and can benefit self-employed individuals who work side jobs as employees.

Investment options: SEP IRAs typically have limited investment options. A 401(k) typically has a wide selection of mutual funds, ETFs, stocks, and bonds.

Mandatory Contributions: An individual’s 401(k) requires the employer to pay contributions based on a percentage of income, but a SEP IRA does not. An individual 401(k) requires your employer to contribute a percentage of your income or a fixed amount, whichever is lower.

SEP-IRA vs. Traditional IRA vs. Roth IRA

Eligibility: SEP IRAs are designed for self-employed or small business owners. Traditional IRAs and Roth IRAs are both available to anyone with income.

Source of Contributions: Employer makes all contributions to her SEP-IRA. All employees contribute to a traditional or Roth IRA.

Contribution limits: SEP-IRA rules allow employers to contribute up to 25% of an employee’s income, or $69,000 in 2024. An employee’s maximum contribution to a traditional or Roth IRA is $7,000 for him in 2024, or $8,000 if he is 50 or older.

Tax Treatment: Contributions to SEP-IRAs and Traditional IRAs are pre-tax and tax deferred until withdrawn at age 59 1/2 or older. Tax will be paid on the amount withdrawn. Contributions to a Roth IRA are made after-tax. They grow tax-free and withdrawals (from age 59 1/2) are also tax-free.

Timestamp: SEP-IRA offers easy setup and flexible contributions.

The SEP-IRA allows self-employed individuals and small business owners to participate in a retirement account that is easy to set up and manage. With a SEP-IRA, business owners and employees must carefully follow all his IRS regulations to avoid penalties and negative tax consequences.

This retirement account is especially beneficial for people who want to set aside more income for retirement than a traditional IRA or Roth IRA would allow in a given year. Employers don’t have to contribute to a SEP plan every year, so people with cyclical income don’t have to worry about not being able to fund their plan during difficult times.