A SEP-IRA (Simplified Employee Pension) allows employers to make retirement plan contributions for their employees. In addition, self-employed individuals may create and fund a SEP-IRA retirement plan for themselves.
Compared to the better-known 401(k) plan, potentially higher contribution limits along with far less complexity are key SEP-IRA benefits.
Who Can Set Up a SEP-IRA?
Any employer can establish a SEP-IRA, including:
- Sole proprietorships
- Unincorporated businesses
An individual with earnings from self-employment may create a SEP-IRA, even if they are also an employee elsewhere and covered by a workplace retirement plan.
Benefits of a SEP-IRA
In addition to being an easy-to-implement retirement savings vehicle, a SEP-IRA can provide large tax benefits.
Contributions to a SEP-IRA provide a tax deduction to the employer (or self-employed individual) for the tax year to which the contributions are designated.
SEP-IRAs lack an annual IRS filing requirement. As further evidence of their simplicity, the paperwork necessary to establish a SEP-IRA is minimal.
Important SEP-IRA Dates
Like regular IRAs and Roth IRAs, contributions to a SEP-IRA can be made following the year to which the contribution applies. In addition, the ordinary SEP-IRA contribution deadline can be extended to as late as the extended due date of the tax return.
The deadline for creating the SEP-IRA is also the due date of the tax return, plus any extensions.
For most people, the SEP-IRA must be established, and the contributions must be made, typically by April 15 following the year the income was earned. Furthermore, most taxpayers may extend their tax returns to as late as Oct. 15 and thereby also receive an extension of time to create and fund their SEP-IRAs.
The IRS extended several tax deadlines for 2020 tax returns. Individual filers now have until May 17, 2021, to file their returns and make contributions. And if you are in Texas or another area where FEMA issued a disaster declaration due to winter storms in 2021, the IRS has extended the deadline contributing to your SEP-IRA. Residents in these affected areas have until June 15, 2021, to make 2020 SEP-IRA contributions.
SEP-IRA Contribution Rules
There is a great deal of flexibility in the amount you contribute to your SEP-IRA. Since the contribution amount can be determined annually, there is no obligation for an annual contribution of a certain amount or percentage.
In any year, the contribution amount can be as little as 0% to as much as 25% of compensation (up to a limit of $285,000 eligible compensation in 2020 and $290,000 in 2021), provided that the total contribution to any one individual does not exceed $57,000 for 2020 and $58,000 for 2021.
Depending on your actual income, the SEP-IRA contribution limit could be greater than the IRA contribution limits of $6,000 in tax year 2020 and 2021 ($7,000 for ages 50 or older). It is often wise to compare SEP-IRA limits to the 401(k) contribution limit for employees (which is $19,500 for 2020 and 2021, or $26,500 for ages 50 or older).
Unlike IRAs and 401ks, SEP-IRAs do not offer any catch-up provisions. But the good news is that the contribution limits are already pretty substantial.
For more information on SEP-IRA contribution limits, see SEP-IRA Limits and Deadlines.
The employer must contribute the same percentage to every employee who is at least 21 years old, earned $600 or more for the year in question ($650 for 2021), and worked for the employer for at least three of the previous five years.
Self-employed individuals who wish to calculate and possibly fund the maximum allowable SEP-IRA contribution should prepare for some head-scratching.
First, the previously mentioned 25% limit is on net profit, not gross revenue. More importantly, the deduction for half of the self-employment tax, as well as the deduction for the SEP-IRA contribution itself, must be subtracted from the net profit number for purposes of calculating the SEP-IRA limit.
Here is a helpful contribution calculator that may be used to determine maximum annual contributions to a SEP-IRA.
However, for important tax matters such as this, it is advisable to consult with a professional tax advisor if you have additional questions regarding the actual contribution amounts to a SEP-IRA.
The IRS provides a helpful list of SEP-IRA resources at IRS.gov. A SEP-IRA is one of many tax-saving alternatives for small business owners to consider. This important retirement plan can be used to reduce taxes and improve your retirement outlook.