Individual Retirement Accounts come in many different flavors to meet different needs and objectives. Traditional and Roth IRAs are probably the most common and well known while SEP and SIMPLE IRAs are less familiar to the masses.
A SEP IRA provides business owners with a simplified, and less expensive, method to contribute to their own and their employees’ retirement. Compared to a 401(k), or other type of qualified plan, a SEP is less expensive, less administratively intense, and less regulated.
SEP stands for Simplified Employee Pension. Who doesn’t like simplified?! Per the IRS, a SEP IRA account is a traditional IRA and follows the same investment, distribution, and rollover rules as traditional IRAs.
Employers and self-employed individuals can establish SEP IRAs. Like traditional IRAs there are limits to annual contributions. The good news is the limits are substantially higher at the lesser of 25% of compensation or $61,000 for 2022 ($58,000 for 2021). Employers are required to contribute the same percentage of salary to all employees SEP IRA accounts. An important note, SEP IRAs are funded by employer contributions only so no catch-up contributions are not permitted as they relate to employee elective deferrals only.
For business owners that have employees, eligibility requirements exist for an employee to participate in the plan. Employees must be included in the SEP plan if they have attained age 21, worked for your business in at least three of the last five years, and received at least $600 in compensation from your business for the year. Note, the compensation requirement is $650 for years 2021 and 2022.
Other interesting SEP facts
- If you are employed by someone else but generate self-employment income you can set up a SEP for your self-employment income.
- If you have a SEP IRA through your employer, you may also have a traditional or Roth IRA and contribute to those on an annual basis according to IRS specified contribution limits.
- You are not required to contribute to a SEP every year.
- Employer contributions to employee SEP IRAs are tax deductible.
SEP IRAs are a powerful retirement savings vehicle for business owners, especially if they don’t have employees or own the business with their spouse. In the case where both spouses are part of the business, they both must meet the eligibility requirements to participate in a SEP IRA plan.