Is a Simplified Employee Pension IRA Right For My Business?

A Simplified Employee Pension IRA–also known as a SEP-IRA–is a retirement savings account that employers can establish for their workers. A SEP-IRA can serve as a good option for smaller employers, self-employed individuals, and those operating in cyclical businesses, to support their employees helping them save for retirement.

Unlike a 401(k), the rules are more flexible and easier to comply with, providing smaller businesses and self-employed individuals with a less onerous option to support their employees.

What is a SEP-IRA?

A SEP-IRA is an employer-offered retirement fund that any business can open for their employers. Similarly to a Traditional IRA, monies are meant to be invested over the long haul (at least five years) and used only once a beneficiary reaches the age of 59.5.

Establishing a SEP-IRA is straightforward, and consists of three basic steps:

(1) Create a written agreement to provide this benefit to all eligible employees;

(2) Ensure that employees are made aware of the particulars of the SEP-IRA;

(3) Set-up an IRA with a bank, insurance company, or other financial institution that offers IRAs.

Only the employer can make contributions to SEP-IRAs; employees cannot make contributions to their SEP-IRA accounts. The employee will need to decide how to invest these monies based on the various options offered by these providers.

What Are the Contribution Limits for a SEP-IRA?

The annual contribution limits are much higher for a SEP-IRA as compared with a Traditional or Roth IRA, and max out at 25% of the employee salary or $69,000 (for the year 2024), whichever amount is lower. This is significantly higher than the limits for both Traditional and Roth IRAs, which in 2024 are capped at $7,000 for those under 50 and $8,000 for those above the age of 50, respectively.

There is no minimum contribution, and employers can also elect not to devote monies to SEP-IRAs when business revenues are lagging. This can make the SEP-IRA a particularly good option for those working in cyclical industries, where revenues tend to fluctuate depending on the macroeconomic conditions in the market.

However, employers must give the same percentage of salary for every employee, including themselves. For this reason, a SEP-IRA often makes the most sense for smaller companies with a limited number of employees or for self-employed individuals.

An employee is defined as an individual above the age of 21 who has worked for the company for at least three out of the past five years, and has made at a minimum amount of money in those years. (The minimum amount for 2024 is $750.) There are a few exceptions to this rule, for instance, if the employee is in a union which has a collective bargaining agreement which includes retirement provisions.

All SEP-IRAs are Traditional IRAs when it comes to taxes. Though employees do not make contributions themselves, the employer can deduct any contributed monies from their annual tax obligations. Once invested, the monies will grow tax free. However, when the monies are withdrawn during retirement, these monies will be taxed at ordinary income rates.

How Does a SEP-IRA Compare to 401(k) Plans?

The SEP-IRA shares a number of similarities with an employer-sponsored 401(k), with the most basic being that the employer is responsible for administering both types of plans.

That being said, there are a number of key distinctions between the two different options.

For one, with 401(k) plans, employees are also making contributions, a percentage of which are often matched by the company. These matches do not automatically “belong” to the employee, however, and many companies attach a vesting schedule to them. Vesting is the idea that employees need to remain employed by their employer for a particular amount of time before they have earned all of the contributions that a company has made on their behalf.

In contrast, the monies invested by an employer into an employees’ SEP-IRA are theirs from the very beginning, and companies do not have an option of requiring a vesting period.

There are also annual limits to contributions that can be made to 401(k) plans, though there is a distinction between employee contributions and employer contributions. For 2024, employees can contribute up to $23,000 in maximum contributions. Employers can contribute even more, though this figure cannot be more than 100% of the employees’ annual salary. For 2024, the combined contribution cannot be more than $69,000 from both parties, though this number rises to $76,500 for those above the age of 50.

Unlike SEP-IRAs, there is a Roth option for 401(k) plans. The Roth pathway allows for individuals to make after-tax contributions to their retirement plan. These monies will not be deducted from tax obligations in the years in which they were made. However, the invested funds will then be allowed to grow tax free, and future distributions (assuming they take place after five years have elapsed and once the beneficiary turns 59.5) will also be tax free.

Conclusion: Who Benefits from a SEP-IRA Plan?

The advantages of a SEP-IRA mostly relate to flexibility and limited overhead, especially as in comparison to a 401(k) plan.

Small businesses and self-employed individuals can establish this mechanism with minimal overhead and management, providing a nice perk for their employees as well as themselves. Employees, if follows, will be the greatest beneficiaries of a SEP-IRA, as the company is providing monies that they will be able to use later on during their retirement years.

Like with every type of retirement savings plan, starting to put money away as early as possible is the most fundamental component. This will allow the wonders of compound interest to perform their magic, helping to increasingly build-up wealth over the long-term as earnings begin to bring in their own earnings.

The purpose of any retirement planning is to provide sufficient savings for the future. SEP-IRA plans can be a great bridge–for both employers and employees–to tread a more secure path towards a more certain financial future.

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