SEP IRAs

What is a SEP IRA retirement plan?

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); 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 IRAs

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) or corporation (S or C); a nonprofit 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 the 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 $650 in 2022 and $750 in 2023 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 2023, employers can contribute either 25% of compensation or $66,000, whichever is less
• For 2022, employers can contribute either 25% of compensation or $61,000, whichever is less
• Contributions to SEP plans are tax-deductible and grow tax-deferred
• Employees who receive contributions are immediately 100% vested

SEP IRA contribution funding deadline

Employers must establish and fund the SEP IRA by the business' tax-filing deadline, including extensions.

Taxation of distributions

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

Required minimum distributions

Generally, individuals must begin taking a required minimum distribution (RMD) from their plan in the year they turn 73 and each subsequent year. For SEP IRAs, there is no exception to the RMD rules for individuals who have not retired.

SEP IRA  vs. SIMPLE IRA

A SEP IRA allows employers to make an annual contribution of the lesser of 25% of an employee's eligible compensation or $66,000 in 2023 and $61,000 in 2022.

Applicable to employers with less than 100 employees, a SIMPLE IRA allows plan participants to defer up to $14,000 pretax or $16,500 if age 50 and older in 2022 and up to $15,500 pretax or $19,000 in 2023, with a required employer match up to 3% of compensation to contributing employees or a 2% contribution to all eligible employees.

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 local Edward Jones financial advisor for more information about all the options available for your plan.