What is a SEP IRA Retirement Account for Small Business Owners – Rules & Contribution Limits

Piggy bank and calculatorIn the past, we’ve talked about the traditional 401k, Roth 401k, Roth IRA, and traditional IRA. We must have hit them all by now, right? Well, if you’re a small business owner or you are self-employed, there’s another retirement fund option that you need to consider: the SEP-IRA.

When I started my own business, one of my goals was to save more for retirement, but the other plans’ costs were too excessive. After doing research, I quickly found that the best option was the SEP-IRA, which offered me a popular low-cost alternative.

SEP-IRA Background and Tax Treatment
Intended as an alternate retirement plan for small business owners and the self-employed, the SEP-IRA (Simplified Employee Pension Individual Retirement Account) allows you to put aside money for yourself and your employees even if you or they are already participating in a 401k or other retirement plan. A few quick aspects of the plan to consider:

  • There are no significant administration costs.
  • Employees cannot contribute to their SEP accounts – only the employer can contribute.
  • Anyone who is 21 or older, has earned at least $500 from the company in the current year, and has worked for the company at least 3 of the past 5 years is considered an employee and must receive their own SEP-IRA account with contributions from the employer. But even before the employee has reached these barometers, the employer can still choose to set up employees with SEP accounts.
  • Contributions to the SEP-IRA account are tax deductible. Unlike the Roth IRA, any investment earnings will be taxed as ordinary income upon withdrawal.

Many of the traditional firms offer SEP-IRAs, such as Fidelity, T. Rowe Price and Vanguard, so you may be able to open an account with a company with which you are already a customer.

How much can you contribute?
You determine the percentage of compensation that you would like to put into your and your employees’ accounts, up to 25% of compensation (20% for unincorporated businesses). However, you and your employees must all receive the same percentage –  so no giving yourself a bigger cut! Each person may receive up to $49,000 in contributions for the year, although this limit may go up in future years. For self-employed businesspeople, you can contribute 25% of net profits adjusted for the self-employment tax, or approximately 18.6% of net profits. You can use this IRA reference guide to calculate the exact amount you can contribute.

When can you contribute?
Contributions can be made at any point during the year and up until the business’ tax returns are due – April 15th for most of us. So if you didn’t have a great year, you can wait until April 15th to come up with the cash to contribute. The deadline for corporations is March 15th or the normal corporate tax filing date. However, if you’re self-employed and didn’t make any profit, you can’t contribute anything to your SEP-IRA for that year. However, you can continue to put money into a traditional or Roth IRA.

When can you withdraw the money?
As with many other retirement plans, you must wait until age 59 1/2 in order to withdraw without penalties. You must begin required distributions at age 70 1/2. Similar to the traditional IRA, some exceptions to the penalties exist, such as medical or educational expenses, or purchasing a home.  Your contributions and the earnings on those contributions are taxed at the time that you withdraw them, at whatever current tax rates exist.

Why should I have an SEP-IRA?
An SEP-IRA is a wonderful tool for the self-employed, especially if your business isn’t very big. In fact, its low cost and simplicity make it perfect for even a very small business. You can contribute over the year or you can make a lump sum payment at any time. The tax advantages are also great – you’ll get to deduct any contributions from this year’s income and save tax-free.

This is an unbeatable deal for any self-employed person. If you have a flush year, you can contribute whenever you have the money and get a great tax deduction. I like to contribute a set percentage of my profits in any month where I turn a profit. It’s small amounts, but they add up over time, and if I have a great year and have maxed out my traditional IRA, I can set aside even more in my SEP-IRA. Plus, most plans have low to no fees, and with all of my contributions in lifecycle funds, I can spend time working on my business instead of rebalancing my portfolio.  Of course that means bigger contributions down the line. There’s never a bad time to start investing and saving for your retirement.

If you’re a small business owner or are self-employed, do you have any experience investing in a SEP IRA?

  • Erin H

    I have an SEP that I contribute to from what I make as a consultant. However, this is not my full time job, so I am limited to a couple hundred dollars a year in contributions. This has made it very difficult to invest it in a way that doesn’t lose money in fees (I don’t have the minimum required for most free investment options).

    Unfortunately, the SEP cannot be rolled over into the SIMPLE IRA I get through the small business I work for. In fact, the SEP seems to have many more roll over restrictions than other types of IRAs, which is very frustrating.

    While I agree that it’s a great option for many people (the SEP is really extremely easy to set up), I would consider carefully whether you actually will be allowed/able to contribute enough to make it worthwhile.

  • http://www.7oil.com Carl D

    We have a SAR/SEP IRA program at my office. The employees can contribute up to the IRA limit. The company owner doesn’t contribute anything except to pay the annual fee.

  • Debraandrews

    I have 4 different small business LLC. with a sep C can I take the $48,000 tax deduction on each account

    • Kira Botkin

      Nope, sorry. The total is for all SEPs combined, and that limit (which is $49k for 2011) also includes contributions you make to other defined contribution plans such as a 401k. Also, if you are self-employed, there is a limit on the amount you can deduct when you contribute on your own behalf to an SEP.

  • Duane Welsh

    Each year I receive a SEP IRA check from my employer and it is endorsed into a investment fund of my choice. This year can I have the check made out to me for my personal use?

    • Kira Botkin

      You’d have to ask your boss, but I would highly doubt it since your boss must contribute the same amount for every person into the SEP.

  • Carl

    Can I contribute to a SEP IRA at age 77?

    • Kira Botkin

      There are no age limits as long as you’re still working and earning money at the company.

  • Hot shot

    I am 68 and My wife is 62. we are buying a home in Utah and are still paying on a home in Nv. If we draw out 10000 from each of a tra ira is the money taxable? if it WAS PUT IN THE IRA AFTER BEING TAXED? Is the only ( ONLY MONEY TAXED IS THE INTREST accrued?.

  • Al B

    I retired in Oct of 2013. Can I continue my SEP-IRA plan or do I need to pick another type plan?

  • TfromO

    My SEP check is made out to Charles Schwab so I can deposit it to my retirement account with them. Would I be able to open up a college IRA for my son and deposit that check into that account so he can use it when he attends college in a few years?

  • KC

    Can I contribute to a traditional IRA and a SEP IRA in one calendar year?

  • Deb

    My boss has told me that he will be giving me a check due to his SEP IRA. Is he Obligated to do this or is it a choice? If I am entitled to it, I need to know as I may be changing jobs very soon. I have a better offer.