A Simplified Employee Pension Plan, or a SEP IRA, is a retirement plan specifically designed for people with self-employment income, like those who are self-employed or are small business owners. A SEP retirement plan can help you contribute funds to your retirement savings account while reducing your taxable income.
Who can contribute to a SEP IRA?
Any employer, including a nonprofit organization, sole proprietorship, partnership, and corporation, with one or more employees, may establish a SEP plan. This includes a self-employed business owner, regardless of whether they are the only employee of the business. Individual employees may not establish a SEP plan. Instead, individual employees who are eligible to participate in the SEP plan must open their own individual Traditional IRAs to which the employer will deposit SEP contributions. Generally, a Traditional IRA that receives SEP-employer contributions is referred to as a SEP IRA and is labeled as such by the custodian.
SEP IRAs have so many advantages over other retirement plans, including:
- Tax-deductible contributions up to 25% of compensation (up to $52,000 in tax year 2014, the highest limit allowed by law)
- Tax-deferred growth potential until withdrawal
- No mandatory contributions or annual tax filings
- Ease of establishing and maintaining the plan
- Reduced paperwork
- Tax-deductible contributions can help decrease current taxable income, and tax-deferred compounding can help both employers and employees build retirement assets. Consult your tax advisor for additional information.
- How contributions are made
- All contributions made to a SEP IRA are employer contributions. An employee cannot defer a portion of their salary and contribute it to a SEP IRA. Employers may contribute up to 25% of an employee’s compensation.
What else to keep in mind
Employers are not required to contribute the same percentage of compensation every year — they may vary the percentage each year, or skip a year altogether. However, in any given year, an employer must contribute the same percentage of compensation for each eligible employee.
SEP IRA contributions must be made by the due date (including extensions) of the employer’s tax return. SEP IRA contributions are reported on Form 5498 in the calendar year in which they are received. Your tax form may reflect both current and prior year contributions if both were received in the same calendar year. Consult tax professionals for more information, and to further familiarize yourself with SEP IRAs.