What is a SEP IRA?
The Simplified Employee Pension is known as the SEP IRA. The SEP IRA is a retirement plan for small business owners and self employed individuals. With a SEP IRA contributions are made by the employer to all eligible employees (employees do not contribute). The 2020 SEP IRA contribution limit is $57,000. Contributions made to a SEP plan are generally 100% tax deductible.
SEP IRAs allow a contribution of up to 25% of compensation up to a maximum of $57,000 for 2020. Employees do not contribute to a SEP plan because they are 100% employer funded. In general, contributions into a SEP plan are 100% tax deductible to the employer.
Investment earnings in a SEP plan grow tax deferred. Withdrawals after age 59 ½ are taxed as ordinary income. If withdrawals are made prior to age 59 ½ you may incur a 10% IRS penalty in addition to ordinary income taxes. Each eligible employee has their own separate SEP IRA account which is then funded by the employer. A SEP plan may be a good option for employers who want to make high contributions to their own accounts and to the accounts of partners or eligible employees. A self employed individual with no employees other than a spouse may also want to consider an Individual 401k as well as a SEP IRA.
SEP IRA Eligibility
Incorporated and unincorporated businesses. Sole proprietors, partnerships, LLCs, Subchapter S and C corporations qualify. Also, individuals with self employed income may be able to contribute to a SEP plan even if they are already covered by a retirement plan (i.e. 401k or 403b) through their full time employer.
Contributions are generally 100% tax deductible and investment earnings grow tax deferred.
100% funded by the employer. Contributions to a SEP plan can be made between 0% to 25% of compensation up to $57,000 for 2020. Contributions are flexible and the percentage of contribution can vary year to year depending on profitability. Contributions do not need to be made each year
SEP IRA contributions for a self employed individual with no employees
Contributions between 0% and 25% of compensation up to a maximum of $57,000 in 2020 can be made into a SEP IRA. For incorporated businesses, compensation is based on W-2 income and there is a 25% maximum contribution. For sole proprietors compensation is based on adjusted earned income. Adjusted earned income is determined by completing an IRS worksheet. SEP contributions of 20% of adjusted earned income can be made for sole proprietors. Annual compensation of more than $285,000 in 2020 cannot be taken into consideration for determining contributions.
Self employed individuals should also consider an Individual 401k as an alternative to a SEP IRA. When compared to a SEP IRA, an Individual 401k may allow a greater contribution at the same income level due to the way the contribution is calculated.
Learn more about the Individual 401k.
SEP IRA contributions for a small business owner with employees
With a SEP plan contributions are made by the employer (employees do not contribute). All eligible employees have their own individual SEP plan. Contributions are made by the employer to the employer's SEP plan as well as to any eligible employee's SEP accounts. The employer can elect to contribute between 0% to 25% of compensation and the percentage of contribution can vary annually at the employer's discretion. The employer and all eligible employees must receive the same fixed percentage. The annual contribution made by the employer is tax deductible.
Who is considered to be an eligible employee in a SEP IRA?
Generally when a SEP plan is established IRS Form 5305 is completed. This short form sets the eligibility requirements for determining who is eligible such as age and length of employment. This form should be kept on file by the employer. When the employer and employees meet the eligibility requirements stated on the completed 5305 form then the employer must make contributions on their behalf. Employers must satisfy the same requirements as the employees. Employers can make the eligibility requirements less strict, but must make contributions to employees if they meet the following 3 requirements:
- 21+ years old
- Have at least 3 years of service in last 5 years
- In 2020 have earned at least $600 in compensation from the employer.
Establishing and funding a SEP IRA
SEP plans are easy to setup and maintain and do not require annual tax filings.
Sole proprietorship, partnership or a LLC taxed as a sole proprietorship - The deadline for establishing and funding a SEP IRA is generally the personal tax filing deadline April 15 (or October 15 if an extension was filed).
Is there an age limit to establishing a SEP IRA?
No. There is no upper age limit to establishing a SEP plan. Provided a sole proprietor has income generated from their sole proprietorship then they are likely to be eligible to contribute to a SEP IRA. Required mandatory distributions are required after age 70 ½ with a SEP IRA.
Withdrawals after age 59 ½ are taxed as ordinary income. Withdrawals prior to age 59 ½ may incur a 10% IRS penalty as well as income taxes. At age 70 ½ Mandatory Required Distributions are required.
SEP IRA calculator
Use the calculator to see how much can be contributed to a SEP plan based on your income. Use the SEP IRA Calculator