Annual SEP-IRA Contribution Limits

A SEP-IRA, or Simplified Employee Pension Individual Retirement Account, is a special type of retirement plan that has some major benefits including the opportunity to take advantage of much higher contribution limits than those available for ordinary 401(k) plans.  SEP-IRA plans are discretionary, which means that it is the employer, not employee, determining how much is added to each account from year-to-year; e.g., in some years, the employer may contribute nothing, while in others, it may contribute the maximum amount allowed under the contribution limits in force for that particular tax year.

 SEP-IRA contribution limits can be taken advantage of until the last applicable tax extension deadline of the sponsor's filing (often September of October of the year following the tax year if the maximum extension is requested).

SEP-IRA Contribution Limits from 2005 - 2016

Specifically, a firm offering a SEP-IRA can contribute between 0% and 25% of an employee's compensation (20% for a self-employed person), provided the contribution limit does not exceed the following amounts:

Tax Year of SEP-IRA ContributionMaximum Annual SEP-IRA Contribution Limit for Workers 49 Years and YoungerMaximum Considered Compensation When Determining SEP-IRA Contribution Limit for Self-Employed Person

SEP-IRA contribution limits are in addition to any applicable contribution limits in effect for a Traditional IRA or Roth IRA.  Contributions to a SEP-IRA are tax deductible to the employer and the employee does not have to pay taxes on the income.  Additionally, the employee can enjoy tax-deferred dividends, interest, rents, capital gains, and other profits until they begin to make withdrawals from the account, at which point it is taxed like ordinary income unless the withdrawals are made prior to the age of 59.5 years old, in which case, there is an extra 10% penalty tax assessed on top of any Federal, state, and local taxes.

One perceived upside or downside of using a SEP-IRA, depending upon your values and where you sit at the table, is that the funding formula selected by the employer must be applied comparably to all employees of the firm meeting eligibility requires.  This can include employees at other businesses owned by the controlling shareholder, member, partner, or sole proprietor (e.g., if you own a manufacturing plant and a car wash, both businesses have to offer similar retirement packages otherwise you could play a game between the two, shove income into one of them, and use it to max out your plan as the sole employee).  This is by design.  Congress didn't want families who own businesses, or a few wealthy people at the top of a business, to be able to enrich themselves through this wonderful tax shelter while neglecting the secretaries, janitors, and minimum wage workers at the bottom.  

The result is that fewer businesses than you might expect to take advantage of the SEP-IRA, preferring instead the SIMPLE IRA, which has lower contribution limits.

 You're more likely to see the former in cases of a highly-paid consultant working alone, a single person or married couple operating a small business without employees, or a close-knit firm where there are a handful of partners engaged in an industry where profit margins are obscenely high.  For example, under the right circumstances, a married couple operating a successful boutique software development firm that sold apps could put away $106,000 per year into their SEP-IRAs between them, taking a huge tax-write off, enjoying potentially decades of tax-deferred compounding, and protecting themselves in the case of bankruptcy.  (SEP-IRAs have unlimited bankruptcy protection, which can make recovering from a financial disaster much easier.  You could walk out of court after having your entire life liquidated and find yourself still collecting dividends on a six or seven figure portfolio held within its protective confines.)

Please note that the formula for self-employed people can be tricky because it involves backing out a certain part of self-employment tax.  You might want to consult with a qualified accountant as there is no need to go into the math here.

The 3 Different Types of SEP-IRA Contribution Limit Formulas

There are several formulas that can be used to determine the allocation of SEP-IRA contributions but, again, they must be applied equally to all employees.  These contribution limit formulas are:

  • The Flat Dollar SEP-IRA Contribution Limit Formula - With this formula, each eligible employee receives a SEP-IRA contribution of the same amount as all other employees.  For example, if the plan sponsor decided to deposit $10,000 into each account for the year, every employee must receive the same $10,000.
  • The Pro Rata SEP-IRA Contribution Limit Formula - A percentage of compensation, up to 25% in most cases, is announced and the SEP-IRA sponsor deposits the applicable amount into each employee's account.  To illustrate: Imagine a firm has three employees, Jane, John, and James.  Jane makes $30,000 a year.  John makes $100,000 a year.  James makes $500,000 a year.  The company decides to match 17% of compensation for the year.  It would need to contribute $5,100 to Jane's SEP-IRA, $17,000 to John's SEP-IRA, and $53,000 to James' SEP-IRA (the reason James can't receive $125,000 is because he has hit the upper SEP-IRA contribution limit of $53,000 for the tax year 2015).
  • The Integrated SEP-IRA Contribution Limit Formula - This one is a bit of a doozy that works to integrate the Social Security formula into the contribution allocation decisions so higher paid employees can receive more in their SEP-IRAs.  Don't try to do this yourself.  Have a respected, knowledgable accountant handle it because if you mess it up, your SEP-IRA may be disqualified and the tax consequences could be dire.

For more information, read our Guide to Retirement Account Contribution Limits.

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