The Simplified Employee Pension IRA (SEP-IRA) provides a great way for self-employed people to save money for retirement, but you have to know the contribution limits and stay within them. You also have to meet certain deadlines.
The Basics of SEP-IRAs
SEP plans provide business owners with a way to save for retirement for themselves and for their workers. Self-employed people and businesses of any size can set up this type of plan. Owners can invest money for each employee. It's a fairly simple account that you can manage with just a little paperwork. There are no annual filing rules.
SEP-IRAs allow you to make tax-deductible contributions and grow your earnings on a tax-deferred basis. Neither the money you put in nor its gains will be taxed until you withdraw them. SEP-IRAs also offer funding flexibility from one year to the next, which can be a real win for businesses with fluctuating fortunes.
You can invest up to the SEP-IRA limits if your business is having a stellar year, or you can choose not to put in any money at all if it's a tight year.
Assets held in SEP-IRAs are treated as traditional IRA assets by law. They're subject to many of the same rules as these IRAs as a result.
SEP-IRA Contribution Limits
One of the nicest features of the SEP plan is the large amount you can put away for retirement. All SEP-IRA contributions are considered to be made by employers on behalf of their workers. You can contribute up to 25% of employee compensation or $58,000 in 2021, whichever is less.
You have to pay in the same percentage of compensation for all of your workers if you're doing so on behalf of others. Your own compensation would be your adjusted self-employment income for the year if you're paying into your own SEP plan.
The annual limit will be subject to future cost-of-living adjustments.
The high limit may allow you to put away more money in a SEP-IRA than you could in other types of plans. These limits are greater than what they are for a traditional IRA limit ($6,000 in 2021 or $7,000 for people age 50 or older).
The 401(k) limit for workers is $19,500 in tax year 2021 or $26,000 for those age 50 or older. SEP-IRAs don't offer any catch-up provisions after age 49, unlike IRAs and 401(k)s, but their contribution limits are already high.
Your Net Adjusted Self-Employment Income
Self-employed persons must use their net adjusted self-employment income as their compensation when they're calculating their SEP-IRA contribution limit of 25%. First, determine your gross income. Now subtract business expenses, including what you paid into your SEP-IRA. Now subtract half your self-employment tax. That is your net adjusted income.
Vanguard provides a useful calculator to help you figure out your maximum contribution to a SEP-IRA, but you might want to consult with a tax professional if you have other questions about how much you can pay in.
Workers can also make tax-deductible traditional IRA contributions to SEP-IRAs if the plan allows for it, but the ability to deduct these may be limited or eliminated because of your participation in the SEP plan.
Like traditional IRAs, SEP-IRAs provide last-minute tax savings to reduce your tax bill as a business owner, but you must meet certain deadlines. A SEP-IRA must be set up by your company’s tax-filing deadline, plus any extensions, for the tax year to which the qualifying contribution applies.
The tax-filing deadline for many small business owners is April 15 in most years. Asking for an extension of time to file will push the date back to October 15. Asking for an extension doesn't give you extra time to pay the taxes that will be due on that return.
The IRS announced in February 2021 that the deadline for 2020 IRA contributions was being pushed back to June 15, 2021 for residents in Texas, Louisiana, and Oklahoma. This change was in response to the 2021 winter storms and the ensuing disaster declarations. It applies to tax payments as well.
Similar SEP-IRA deadlines apply when you're contributing funds. SEP-IRA contributions can be made for the prior year, up until the tax filing deadline. You can set up the account and pay into it until April 15 or October 15. Be sure to notify the IRA custodian to code the contribution for the prior year if that's your intention.
Keep SEP-IRA Limits in Context
There are other retirement plans for small businesses and self-employed persons, such as SIMPLE IRAs, individual 401(k)s, Keoghs, or regular 401(k)s. It makes sense to compare these options and decide which one is right for your needs.
Frequently Asked Questions (FAQs)
Can part-time employees invest in a SEP-IRA?
As long as you are over the age of 21, have worked with the business for three of the past five years, and earned at least $650 with the business in the past year, then you are able to invest in a SEP-IRA.
Where do I report SEP-IRA contributions on Form 1040?
For those who are self-employed, you can report the contributions you make to your SEP-IRA on Form 1040, Line 28. You must report contributions made as it relates to the tax year that the SEP is established under.