A Simplified Employee Pension IRA (SEP IRA) is one of the easiest workplace retirement plans to set up and maintain, for any business.
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 $600 in the current year (2020/2021) 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, employers can contribute either 25% of compensation or $57,000, whichever is less
- For 2021, employers can contribute either 25% of compensation or $58,000, which 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 72 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 vs. Owner-only 401(k) contribution limits
A SEP IRA allows employers to make an annual contribution of the lesser of 25% of an employee's eligible compensation or $57,000 in 2020 and $58,000 in 2021.
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 contributionss (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 in 2020 and $58,000 or $64,500 if age 50 or older in 2021.
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.
This information is for educational purposes only.
Edward Jones, its employees and financial advisors are not estate planners and cannot provide tax or legal advice. Please consult your attorney or tax professional regarding your situation.