A simplified employee pension (SEP) is a type of individual retirement account (IRA) that can be set up by an employer or a self-employed individual. The employer can deduct contributions made to a SEP IRA from their taxes and can choose how much to contribute to each eligible employee’s account.
Moreover, with the SECURE Act passed on Dec. 20, 2019, small businesses are eligible for a tax credit to help cover the expenses of initiating a 401(k) plan or SIMPLE IRA with automatic enrollment. This tax credit is in addition to the start-up credit they already receive.
SEP IRAs usually allow for larger yearly contributions compared to regular IRAs. They combine features of both traditional IRAs and 401(k)s. Similar to 401(k)s, they can receive contributions from employers, and like traditional IRAs, contributions are immediately vested.
How Does Simplified Employee Pension Works?
A SEP IRA is a good choice for business owners because it has lower costs than other retirement plans. Some employers use a SEP IRA to save more for their own retirement than with a traditional IRA.
Small businesses prefer SEP IRAs due to the eligibility criteria for contributors, such as being at least 21 years old, having worked for at least three years, and earning a minimum of $750 in 2024. Moreover, a SEP IRA permits employers to forgo contributions in lean business years.
SEP IRAs have similar tax treatment as traditional IRAs and offer the same investment choices. The transfer and rollover regulations for traditional IRAs also pertain to SEP IRAs. Employers get a tax deduction when contributing to a SEP IRA. Unlike traditional IRAs, businesses are not obligated to make annual contributions; they can decide each year whether and how much to contribute. However, there is a maximum limit of $69,000 in 2024.
The employer does not make investment decisions. The IRA trustee decides which investments are allowed, and the individual employees who own the accounts make the actual investment choices. The trustee also handles contributions, sends yearly statements, and submits all necessary paperwork to the IRS.
SEP IRA contributions are fully vested right away, and the owner of the IRA decides where to invest the money. Any eligible employee, including the business owner, who joins their employer’s SEP plan needs to open a traditional IRA for the employer to deposit the contributions.
Certain banks need the traditional IRA to be called a SEP IRA before accepting SEP contributions. Other banks may accept SEP contributions for a traditional IRA, even if it’s not labeled as a SEP IRA.
Conclusion
A SEP IRA is a retirement plan for small business owners and eligible employees. It allows for larger contributions and income limits compared to other retirement plans. Business owners need to select a plan provider and make contributions to set it up. If they have employees, they must also contribute to their plans equally.