Most people save for retirement with the help of their employer’s retirement plan. This is typically a 401(k) which is offered as part of an employee benefits package. If you’re an owner of a small business or self employed, you’ll need to provide your own retirement plan which would be the SEP IRA, or Simplified Employee Pension plan.
SEP IRAs let you defer taxes on investment growth and contributions in the account. Although withdrawals in retirement will be taxed as ordinary income, the potential for years of compound growth without current taxation makes it possible to accumulate a larger nest egg than you could in an ordinary, taxable brokerage account.
SEP IRAs are available to any business, no matter the size. They’re best suited to self-employed individuals, small-business owners, or members of a partnership. Their main points are low cast and simplicity. They include fewer administrative responsibilities than other types of retirement accounts, and generally don’t impose start-up costs or annual fees. They also carry restrictions that may not suit larger businesses.
SEP IRAs are funded only by employer contributions. Employees can’t contribute on their own behalf. The accounts let you set aside a lot more money than most other retirement accounts.
This advantage comes with an important caution for business owners with employees. If you set up a SEP IRA for yourself, you must also establish one for each eligible employee, or they can make their own. If you contribute for yourself in a given year, you have to contribute the same percentage of salary to each employee’s account as well.
Same with regular IRA contributions, you have until tax filing deadline to make SEP IRA contributions for a given calendar year. It could be as late as October of the following year if you’ve filed a tax extension.
Simple retirement solution
Establishing a SEP IRA is pretty easy and simple. Most financial institutions that offer retirement accounts provide SEP IRAs, and setting up one takes a little bit more work than opening a traditional IRA.
Once the account is funded, you and any employees can invest in any of the investment options offered by the account provider. SEP IRAs generally offer a lot more investment options than other workplace plans, giving you and your employees greater flexibility to design portfolios that suit your needs. The accounts have the same investment caps as ordinary IRAs, including restrictions on coins, collectibles, real estate that you derive a direct benefit from, and certain types of derivative positions.
Administering a SEP IRA is very simple and inexpensive. You don’t need to fill out the IRS Form 5500. Providing a SEP IRA to eligible employees does involve certain responsibilities. Employers must have a record of the plan agreement on file (doesn’t have to be filed with IRS). The IRS recommends, but does not require, using Form 5305 for this purpose. You’re required to have a written agreement with employees that outlines the details of the plan and notes the dates of contributions to their accounts.
Access to assets
Employees are 100% vested in any SEP IRA assets as soon as you contribute money to the account. This is something to consider if you want to use the account to retain valuable employees. The rules governing access to the assets are similar to the rules for traditional IRAs:
- You can’t borrow from a SEP IRA
- Withdrawal funds prior to age 59 ½ can be subject to a 10% early withdrawal penalty, along with any applicable income taxes
- You must take required minimum distributions from SEP IRAs beginning at age 70 ½.
- You can roll assets from another retirement account to your SEP IRA.
- You can roll your SEP IRA assets to another IRA.
- You can make a withdrawal from your SEP IRA prior to age 59 ½ without having the early withdrawal penalty in specific scenarios, including financial hardship, education expenses, etc..
The CARES act temporarily waives required minimum distributions (RMDs) for all types of retirement plans (including IRAs, 401(k)s, 403(b)s, 457(b)s, and inherited IRA plans) for calendar year 2020. This includes the first RMD, which individuals may have delayed from 2019 until April 1, 2020.
If you’re self employed, there’s a high chance a SEP IRA offers the best combination of features, including flexibility, cost, contribution limits, and investment options. The decisions are complicated if you have employees. In that case you need to weigh the account’s appealing features against the mandate to contribute for your workers whenever you contribute for yourself. If that requirement isn’t heavy, this account can provide a good way to save for your own retirement while offering employees their suited benefit.