As a small business owner, you care about the future well-being of your employees. Just as you keep them safe physically and emotionally in the workplace, you want to be sure you’re helping protect their future retirement as well. In doing so, you may have searched for effective avenues in helping employees (and yourself) contribute to their nest egg. If you're seeking alternative options to a formal profit-sharing plan, a SEP IRA (Simplified Employee Pension Individual Retirement Account) may be the answer.
With low administrative fees, flexibility and lower costs, here are five other facts employers (and self-employed persons) need to know about SEP IRAs.
1. SEP IRAs Differ from Traditional and Roth IRAs
Traditional and Roth IRAs are opened by individuals, they are not operated through or sponsored by an employer. SEP IRAs, on the other hand, are tied to your place of employment. A business owner, whether they have employees or are self-employed, sets up a SEP IRA account for employees and makes contributions to all accounts (including his or her own).
Setting up a SEP IRA can offer employers certain tax breaks and, like a traditional IRA, employees are not taxed on the contributions until funds are withdrawn.
2. Contribution Limits Are Higher
The deadline for making tax-deductible IRA contributions for a given tax year is usually April 15, unless we're in the middle of a pandemic. For the 2021 tax season, traditional and Roth IRAs have a contribution limit of $6,000 — or $7,000 for those 50 and older.1
The SEP IRA has a contribution limit for the 2021 tax year of $58,000, or 25% of the employee’s income, whichever is less. There are no minimum contributions required.2
The SEP IRA can be opened and funded after the tax year ends up through any tax filing extension. SEP IRAs provide a flexible way for employers to look at the end-of-year company financial state and make SEP IRA contributions accordingly. Just like other pension plans at larger companies, employees do not contribute to the SEP, only the employer is permitted to contribute.
3. SEP IRA Have Certain Eligibility Requirements
In order to be eligible to participate in an employer-sponsored SEP IRA, employees and business owners must:
- Be 21 years of age or older.
- Have worked for the employer in the last three of the previous five years.
- Have earned at least $600 from the employer during the previous year.3
An employer may choose to be less restrictive in their eligibility requirements, however, they cannot be more strict than the requirements listed above.
Also, be aware that if you are a business owner and contribute to your own SEP IRA account, you must also make the same percentage contribution to your eligible employees’ accounts.4
4. You May Exclude Certain Employees from SEP IRA Contributions
There are certain instances in which employees within your company may be excluded from your SEP IRA plan. According to the IRS, these include:
- Those who are part of a union agreement and/or their retirement benefits are a result of collective bargaining.
- Nonresident alien workers who receive no compensation from the employer.3
Employees who participate in an employer-sponsored SEP IRA are 100% vested in their SEP IRA accounts. In other words, whatever the employer contributes immediately belongs to the employee. The funds can be transferred directly or rolled over into other IRAs.
5. You Must Begin Withdrawing from Your SEP IRA at Age 72
Like Traditional IRAs and 401(k) plans, you must begin taking required minimum distributions when you reach age 72. This is a recent change thanks to the SECURE ACT passed in December 2019. The previous age to begin taking required minimum distributions was 70½.5
However, with recent legislation changes from the SECURE Act, contributions can continue to be made to your SEP IRA with no age cap for as long as you continue working with that employer.
Early withdrawals (before age 59½) are generally subject to a 10% tax penalty, although there are certain scenarios in which individuals may withdraw from their SEP IRA penalty-free. These instances include:
- Birth or adoption of a child within the past year (up to $5,000 per parent).
- First-time homebuyers (up to $10,000).
- Medical expenses (exceeding 10% of an individual’s gross income).
- Total or permanent disability.
- Qualified members of military reserves called to active duty.
- Higher education expenses.6
If you have a small business or a limited number of employees, the SEP IRA has many of the features of a regular IRA, and the contributions are subtracted from your taxed income. The biggest advantage is the large amounts you can set aside for retirement.
Setting up a SEP IRA is a simple and inexpensive option to help you and your employees build a nest egg. You can open a SEP IRA at any bank, mutual fund company or brokerage firm with low (or no) annual account fees. If you are looking for an incentive to lure and retain good employees, a SEP IRA could be an attractive advantage.
This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.