What Is a Simplified Employee Pension (SEP) IRA Retirement Account?

Need to save for retirement as a self-employed employee, and get comparable tax advantages as staff with retirement plans?

The simplified worker pension particular person retirement account — or SEP IRA as much less of a mouthful — helps you do exactly that. All with out the pink tape and bills of a solo 401(k). 

What Is a Simplified Worker Pension (SEP) IRA Retirement Account?

Because the identify suggests, a SEP IRA is a sort of IRA. It serves as a tax-advantaged account the place you’ll be able to put money into shares, bonds, ETFs, mutual funds, REITs, and different publicly-traded property. 

You may open a SEP IRA with a standard funding brokerage, reminiscent of T. Rowe Price, Fidelity, or Vanguard. You management your individual investments, and may log in to contribute funds and commerce any investments obtainable by your brokerage.

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The federal authorities designed these accounts particularly for retirement, and doesn’t assist you to withdraw cash till you attain retirement age. 

SEP IRA Guidelines

Like different tax-sheltered brokerage accounts, SEP IRAs include loads of guidelines and restrictions. Be sure you perceive them earlier than creating an account or contributing funds.

Eligibility

To start with, you should be self-employed to open a SEP IRA. That features small-business house owners, freelancers, gig economy workers, and different self-employed people. 

Nevertheless for those who run a enterprise with staff and open a SEP IRA for your self, you will need to additionally permit your staff to take part. The truth is, you must contribute the identical share of their earnings to their SEP IRA account as the proportion of your earnings that you simply contribute to your individual account. 

For instance, for those who contribute 10% of your earnings to your SEP IRA, you will need to additionally contribute 10% of every qualifying worker’s earnings to their SEP IRAs too.

Meaning SEP IRAs work finest for solopreneurs with no staff. In addition they serve nicely for small household companies, the place you don’t thoughts shelling out employer contributions on your kids’s retirement accounts. 

Eligible staff embrace these 21 years of age or older, who earn not less than $650 per yr, and who aren’t lined below a collective bargaining settlement. You additionally don’t need to contribute for nonresident employees in different nations. 

You additionally don’t need to decide to a sure contribution share annually. In a down yr for your corporation, you’ll be able to contribute much less — or nothing — to your and your staff’ SEP IRAs. 

Tax Advantages

You rating an instantaneous tax deduction this yr for the quantity you contribute to your SEP IRA. In that sense, the tax deductions work like traditional IRAs or 401(k)s.

Nevertheless in contrast to these accounts, there’s no Roth choice for SEP IRAs. You don’t have the choice to pay taxes on SEP IRA contributions now, in trade for tax-free compounding and paying no taxes on withdrawals in retirement. 

That mentioned, you’ll be able to contribute to a SEP IRA after which later roll over funds to your Roth IRA, as a backdoor Roth contribution.

Contribution Limits

It’s possible you’ll contribute as much as 25% of your self-employed earnings to a SEP IRA. The IRS caps your annual contribution at $58,000 for tax yr 2021, and $61,000 for 2022. The IRS doesn’t impose earnings limits for eligibility: you’ll be able to contribute as much as the utmost quantity and deduct it, no matter how a lot you earn. 

For many People, that makes SEP IRAs a extra versatile choice than conventional IRAs, permitting a better contribution. 

Be aware that you would be able to contribute to each a SEP IRA and a standard or Roth IRA in the identical yr.

Not like conventional and Roth IRAs nevertheless, SEP IRAs don’t supply a better catch-up contribution allowance for employees age 50 and over.

Withdrawals and Required Minimal Distributions (RMDs)

As a result of SEP IRAs provide you with an instantaneous tax deduction in your contribution, you will need to pay taxes on withdrawals in retirement. 

In the event you withdraw cash earlier than age 59 ½, the IRS hits you with a ten% early withdrawal penalty plus taxes on the withdrawal, identical to conventional IRAs.

And like conventional IRAs, you will need to begin taking required minimum distributions (RMDs) by age 72. The higher to tax you with, my pricey. 

Deadlines

You may contribute to your SEP IRA up till the tax submitting deadline, normally April 15. That offers you time to arrange your tax return for the earlier yr earlier than deciding how a lot to contribute. 

Beware that submitting for an extension in your tax return deadline doesn’t change your contribution deadline nevertheless. 

Execs and Cons of SEP IRAs

Small-business house owners have a number of choices obtainable to them for retirement plans, from SIMPLE IRAs to 401(ok)s and past. 

Earlier than you choose a SEP IRA, be sure to perceive how the professionals and cons of every evaluate.

Execs of SEP IRAs

For the proper sort of self-employed employee, SEP IRAs supply tempting advantages.

• Excessive contribution limits. Whereas conventional and Roth IRAs permit solely $6,000 in annual contributions for employees below 50, you’ll be able to contribute as much as $61,000 in 2022. 
• Contribute to a number of accounts. Why select? You may contribute to each your SEP IRA and a Roth or conventional IRA for those who like. 
• Versatile funding choices. Since you open and handle your SEP IRA by an everyday funding dealer, you’ll be able to put money into almost any publicly traded asset. 
• Simple to open and administer. Not like 401(ok)s, SEP IRAs include just about no administrative complications or charges. 
• Versatile contributions. You select how a lot you wish to make investments annually, with out being locked right into a share. 

Cons of SEP IRAs

Like all funding and retirement accounts, SEP IRAs include their fair proportion of downsides.

• Should supply to qualifying staff. No matter share of your individual earnings you contribute, you will need to match the identical share for every worker. That makes SEP IRAs impractical for many companies with staff.
• No loans. Not like 401(ok)s, you’ll be able to’t borrow cash towards your SEP IRA steadiness. 
• No Roth choice. You may’t decide to pay earnings taxes on contributions now, in favor of tax-free progress and withdrawals in retirement. 
• No increased catch-up contribution restrict. Older employees can’t contribute extra to compensate for their retirement financial savings.
• Required minimal distributions. Beginning at age 72, it’s essential to begin draining your SEP IRA and paying taxes on withdrawals.

Closing Phrase

For sole proprietors, enterprise companions with no staff, and small household companies, SEP IRAs can supply the proper retirement plan. You profit from excessive contribution limits whereas sustaining full management over your investments, and keep away from the executive complications and costs of 401(ok)s.

However as you add staff, beware that you must cough up cash for his or her retirement accounts too. Communicate with a tax advisor earlier than establishing a SEP IRA plan for your corporation.

Nonetheless, the mixed perks make SEP IRAs a streamlined and savvy approach for entrepreneurs and freelancers to save for retirement.