A Simplified Employee Pension IRA (SEP-IRA) plan is a type of workplace retirement plan that allows an employer to contribute tax-deductible dollars to the owner's and the employee's retirement account. SEP-IRA plans are funded solely by employer contributions (employee deferrals are not permitted) whereby each eligible employee generally receives the same percentage of their individual compensation amount, and that percentage is at the discretion of the employer from year-to-year.

Benefits of SEP-IRA 

SEP-IRA plans offer a range of benefits, including

• SEP-IRAs are relatively simple and inexpensive.
• Plans do not require special IRS filings or administration.
• SEP-IRA contributions are tax deductible to the employer.
• Annual contributions to the plan are not mandatory and may range from 0-25%.

SEP-IRA Rules

A SEP-IRA plan can be established by any type of business, including a sole proprietor, partnership, limited liability company (LLC), corporation (S or C); a non-profit organization; or even a government entity. It's important to consider the rules around eligibility, contributions and distributions in determining the suitability of a SEP-IRA.

SEP-IRA Eligibility

When an employer establishes a SEP-IRA, they must decide on the eligibility requirements of the plan – which will vary based upon their objectives. Everyone, including the business owner(s), is subject to these eligibility requirements.

An employer can set up a SEP-IRA with the following maximum eligibility requirements (but can choose to be more lenient):

• Age 21 or older
• Worked for the employer during three of the last five preceding years, and
• Expected to earn at least $600 in the current year (2019/2020) from the employer sponsoring the SEP

Like other retirement savings accounts, certain individuals may be excluded from a SEP-IRA including:

• Individuals covered by a collective bargaining agreement (generally union employees), whose retirement benefits were bargained for in good faith
• Non-resident alien employees who have received no U.S. source wages, salaries, or other personal services compensation from the employer

SEP-IRA Contributions

• For 2020, you can contribute either 25% of your compensation or $57,000, whichever is less.
• Contributions to SEP plans are tax-deductible and grow tax deferred.
• Employees who receive contributions are immediately 100% invested.

SEP-IRA Contribution Funding Deadline

Taxation of distribution

Distributions from SEP-IRAs follow the same distributions rules as traditional IRA and are typically taxed as ordinary income. While a distribution can be taken at any time, a 10% penalty on pre-tax dollars will be incurred if the individual is under age 59½ and does not qualify for a penalty exception.

Required minimum distribution

Generally, individuals must begin taking a required minimum distribution (RMD) from their plan in the year they turn 70 ½ (for individuals who attained this age in tax year 2019 or prior) or age 72 (beginning in tax year 2020) and each subsequent year. For SEP-IRAs, there is no exception to the RMDs rules for individuals who have not retired.

SEP-IRA vs. SIMPLE IRA vs. Owner-only 401(k) Contribution Limits

A SEP-IRA allows employers to make an annual contribution of the lesser of 25% of your eligible compensation or $57,000.

Applicable to employers with less than 100 employees, a SIMPLE IRA allows plan participants to defer up to $13,500 pretax or $16,500 if age 50 and older, with a required employer match up to 3% of compensation to contributing employees or a 2% contribution to all eligible employees.

An Owner-only 401(k) is available to businesses consisting solely of owner(s) and spouse(s) and may offer the ability to contribute more than the dollar limits of a SEP-IRA at the same compensation: 25% plus salary deferral contributions (pretax or Roth) of up to $19,500, plus a catch-up contribution of up to $6,500 if age 50 or older; maximum $57,000 or $63,500 if age 50 or older.

How we can help

The low cost and simplicity of a SEP IRA can be appealing, but how do you know if it's right for you? Ask your financial advisor for more information about all the options available for your plan.