Entrepreneurs can choose from multiple methods to save for their retirement and that of their staff. However, with numerous choices available, determining the right plan for you and your business can be challenging. 

One option is a Simplified Employee Pension (SEP), and it involves placing funds into an Individual Retirement Account (IRA) for all participants in the plan. In this post, you’ll dive deeper into the eligibility criteria for a SEP-IRA, the pros and cons one comes with, how you can set one up, and how you can determine if one is right for you.

Who Can Establish a SEP-IRA and What Are the Rules?

In essence, any employer can establish a SEP-IRA. However, it is typically more appropriate for companies with little to no staff, as the IRS mandates contributions for all qualifying participants.

The percentage of salary contributed to participants’ accounts must be equal to that of the owner’s contribution. For example, if a business owner adds 10% of their salary to their SEP-IRA, they are also obligated to contribute 10% of an eligible participant’s salary to their corresponding account.

Employees are required to be part of the SEP plan if they meet the following criteria:

• Reached the age of 21;
• Been employed by your company for a minimum of 3 out of the past 5 years;
• earned a minimum of $750 in 2022, $650 in 2021 and 2022, or $600 in compensation (between 2016 and 2020) from your business annually.

Your plan can also implement more lenient eligibility requirements. For example, employees may only need to be 18 years old or have been employed by you for 3 months. 

SEP-IRA Contribution Limits for 2023

Although SEP-IRAs permit substantial contributions, there are still annual limits. These limits may change each year based on new IRS guidelines.

 In 2023, contributions cannot exceed the lesser of:

• 25% of compensation, or
• $66,000 in total

The 25% rule is applicable to every plan participant, including the business owner. For 2023, the highest salary considered for determining the 25% is set at $330,000. Also, no catch-up contributions are allowed for SEP-IRAs, regardless of given participant’s age.

Advantages of a SEP-IRA

The advantages of a SEP-IRA include:

Elevated Contribution Limits: SEP-IRAs allow for notably larger contributions, up to $66,000 in 2024, compared to other retirement plans like traditional and Roth IRAs, which have a $6,500 limit ($7,500 if 50 or older).

Tax-Deductible Contributions: Contributions to SEP-IRAs are tax-deductible, allowing you to claim deductions for your contributions within the IRS-approved limit during tax season.

Adaptability: SEP-IRAs can be used in conjunction with other IRA accounts, including traditional or Roth IRAs, broadening retirement savings possibilities.

No Mandatory Annual Contributions: With no requirement to contribute to a SEP-IRA each year, managing your retirement plan becomes more flexible.

Disadvantages of a SEP-IRA

The disadvantages of a SEP-IRA include:

Absence of Catch-Up Contributions: For individuals approaching retirement, SEP-IRAs do not offer catch-up contributions at age.

Lack of Roth Alternative: There is no Roth SEP-IRA variant, which means after-tax contributions are unavailable.

Employer Contribution Requirements: For businesses with employees, employers must contribute equally to all eligible workers’ accounts. This potentially increases costs for business owners.

Penalties for Premature Withdrawals: Taking out funds prior to turning 59½ years old leads to income taxation and a 10% penalty, except in cases where an early withdrawal exemption applies.

How to Set Up a SEP-IRA

Establishing a SEP-IRA for your business is fairly straightforward. Generally speaking, the process follows the steps outlined below:

Step 1) Choose a Financial Institution: Select a reputable financial institution (e.g. bank , brokerage, or mutual fund provider) to serve your plan’s trustee. 

Step 2) Create a Written Agreement: Establish a written agreement using IRS Form 5305-SEP, Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement, or a similar document provided by your chosen financial institution. This agreement outlines the terms of your SEP-IRA plan. It will include things such as your plan’s eligibility requirements and contribution rates.

Step 3) Inform Employees: Notify any eligible employees about your SEP-IRA plan. Provide them with information about the plan’s terms, the institution holding the plan, and how to open an individual SEP-IRA account.

Step 4) Establish SEP-IRA Accounts: Set up individual SEP-IRA accounts for each of your eligible employees. This can be done through the financial institution you chose or by instructing your employees to open their own accounts with the institution.

Step 5) Contribute to the Accounts: Make contributions to the SEP-IRA accounts according to the terms explained in your written agreement. Ensure that your contributions are made on behalf of all eligible employees. Additionally, make sure that they are made consistently and fairly based on the appropriate percentage of each employee’s salary.

Step 6) Monitor and Maintain the Plan: Regularly review the performance of the investments in your SEP-IRA account(s). Make adjustments when necessary, and keep track of contribution limits, which may change annually. Lastly, ensure ongoing compliance with IRS rules and regulations.

Step 7) File Necessary Paperwork: Complete any required reporting to the IRS, such as including SEP-IRA contributions on your annual tax return. Keep accurate records of all contributions and plan-related documents for tax purposes and in case of an audit.

How Fisher Investment Strategies Can Help You Further

At Fischer Investment Strategies, we recognize the importance of selecting the right retirement plan for you and your business. A SEP-IRA can offer several advantages, but it also comes with its own set of drawbacks that need to be considered. Our mission is to assist you in the decision-making process and identify the solution that’s right for you.

Our group is committed to offering tailored advice in all facets of retirement planning. We can help you assess whether a SEP-IRA is the right choice for your business, and if so, guide you through the process of setting one up. Additionally, we’ll work with you to ensure that your retirement plan remains aligned with your financial goals, making any necessary adjustments as your business grows and evolves.

Don’t leave your retirement planning to chance! You can call us directly at our Westlake office at (805) 418-7686, or our San Clemente office at (949) 433-7768. Feel free to also schedule a complimentary consultation at a time that works best for you.