Spotlight – What Do You Need to Know about SEP IRAs?

A report dated 2021 created by the Pew Research Center stated that 16 million people in the US are self-employed. This means they are not eligible for a retirement plan from their employers. Thanks to SEP IRAs, self-employed individuals now have an additional savings option to boost their retirement plans. The SEP IRA has a competitive maximum contribution as well as remarkable flexibility.  

But what exactly is a SEP IRA? And how does it work? Let’s learn all about it in this guide.  

SEP IRA Explained 

The Simplified Employee Pension Individual Retirement Account, or SEP IRA, is like a traditional IRA with more perks. It’s a tax-deferred retirement plan for people who are self-employed, business owners, employers, and those who engage in freelance work. Contributions made to a SEP IRA are considered employer contributions. It’s designed for simplicity, especially when you run your own business and have no—or relatively few other employees.  

How Does a SEP IRA Work? 

SEP IRAs are excellent retirement plan options because they are flexible, low cost, and easy to set up and manage. Also, they have more generous contribution limits and tax benefits than other retirement savings vehicles. You don’t need to worry about the operating and start-up costs associated with conventional employer retirement plans.  

SEP IRAs have the same tax treatment and investment options as most traditional IRAs. Both IRAS also have similar rollover and transfer rules. Also, employers receive a tax deduction for every contribution made to an employee’s account. And the amount of contribution can be different every year.  

SEP IRA Contribution Limit 

You are allowed to stash as much as $6,000 every year into traditional IRAs. But, with a SEP IRA, you can invest more than 10 times that amount. Just be aware that SEP IRAs also have annual contribution limits. You cannot exceed 25 percent of compensation, or $58,000 in 2021 and over $61,000 in 2022. Contributions must be identical percentages for all recipients/employees. 

Advantages of a SEP IRA 

SEP IRAs are very convenient for the employer. Everything is simple, easy to set up, and easy-to-navigate. Every contribution is tax-deductible for the employer, and it’s flexible. No commitment to a specific yearly contribution amount is needed.  

Disadvantages of a SEP IRA 

SEP IRAs have various disadvantages which you should be aware of. Firstly, only the employer can contribute. Additionally, the SEP IRA does not have a Roth option. This means that you must pay taxes on your distributions. Additionally, once you reach the age of 72, you must take required minimum distributions ( RMDs) . However, you can convert the SEP IRA account to a ROTH IRA at any time, and thereby avoid all future taxation and all future RMDs.  

How to Start with a SEP IRA 

If a SEP IRA sounds like it might be a good move for you, you can open one pretty easily. All you have to do is follow these three steps outlined by IRS: 

1. You should have a formal written agreement. This is done by filing IRS Form 5305-SEP. If you have an account provider, or IRA custodian,  they can help you.  

2. Let your eligible employees know about your plans to apply for a SEP IRA. You can provide them with a copy of your IRS Form 5305-SEP.  

3. Create separate SEP IRA accounts for yourself and eligible employees through your chosen account provider.  

Investing Using a SEP IRA 

The investments you make in your SEP IRA account depend on your current age, your anticipated retirement age, and your risk tolerance. Before choosing your investments, you should have an idea about what your future needs will be. Most asset allocation models would suggest weighing retirement portfolios toward stocks when you’re younger. As you grow older, you can start reducing your portfolio risks. Then, it’s time to boost your income component by rebalancing.  There are almost no limits on what you can invest in, in your SEP IRA accounts. It is best to utilize the services of a professional advisor as well.  Retirement planning and asset management is generally not a do it yourself situation for most people! 

Withdrawing Money from a SEP IRA  

If you want to withdraw your contributions before you retire, that’s a possibility with this type of IRA. However, any amount you withdraw serves as taxable income. This means that you should set aside an appropriate amount based on your current marginal income tax rate. The distribution or withdrawal can also be subjected to an additional 10 percent penalty tax if you are under age 59 ½. Contacting your tax consultant is best if you’re considering withdrawing before retiring.  There are ways to avoid the 10% early withdrawal penalty with proper planning as well. 

Alternatives to a SEP IRA  

While a SEP IRA is an excellent option for people who are self-employed, it’s nice to look at the following alternatives: 

SIMPLE IRA: Ideal when you’re a small business owner with fewer than 100 employees. 

Defined Benefit Plan: This plan locks you into minimum annual funding regardless of market performance. 

Solo 401(k): Great for flexible and tax-deductible contributions. However, it comes with more maintenance and set-up fees than other options. 

Profit Sharing Plan: A plan that lets you contribute when and how much you want. 

The Bottom Line 

A SEP IRA is ideal for self-employed individuals looking for tax-advantaged retirement savings vehicles. This unique IRA allows you to contribute significant amounts every year. You can watch your savings grow, tax-deferred. Carefully weigh the factors and decide whether an SEP-IRA might be the right choice for you. 

Published by Robert Ryerson

A financial professional with more than three decades of experience, Robert Ryerson works closely with clients in the Freehold, New Jersey, area to meet their financial planning needs. As a Certified Financial Planner (CFP) at New Century Planning, he focuses on retirement income planning, as well as estate administration, regularly assisting his clients with legacy and estate planning. He also advises them on health and disability insurance, including Medicare, Medicaid, and Medicare Supplement Plans. Mr. Ryerson’s many years helping his clients navigate the complexities of retirement planning gave him a deeper understanding of the healthcare costs that retirees face. In 2013, he drew upon this knowledge to co-author the book What You Don’t Know About Retirement Will Hurt You. Outside of his work at New Century Planning, Robert M. Ryerson is a regular fixture at workshops and seminars on retirement. He has delivered several keynote speeches on the often-confusing topic of required minimum distributions. Mr. Ryerson continues to share his financial expertise as a facilitator of online courses for Certified Public Accountants through The Society for Financial Awareness. In the early 2010s, Mr. Ryerson became concerned about the threat of identity theft after noting the many cybersecurity breaches suffered by major companies. He became a Certified Identity Theft Risk Management Specialist (CITRMS) in 2014. He has since taught identity theft recovery courses at local community colleges. Mr. Ryerson also wrote a book on the topic entitled What’s the Deal with Identity Theft: A Plain English Look at Our Fastest Growing Crime. A graduate of Rutgers University with a degree in economics, Mr. Ryerson began his career in the financial services industry as a stockbroker. He obtained his CFP designation in 1991 and began working as an independent financial planner a few years later. In addition, he is a notary public.

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